Optimal Monetary Policy under Asset Market
Segmentation
Date
2017-06-01
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Singh, Rajesh
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Economics
Abstract
This paper studies optimal monetary policy in a small open economy
under flexible prices. The paper's key innovation is to analyze this question
in the context of environments where only a fraction of agents participate in
asset market transactions (i.e., asset markets are segmented). In this
environment, we study three rules: the optimal state contingent monetary
policy; the optimal non-state contingent money growth rule; and the optimal
non-state contingent devaluation rate rule. We compare welfare and the
volatility of macro aggegates like consumption, exchange rate, and money
under the different rules. One of our key findings is that amongst non-state
contingent rules, policies targeting the exchange rate are, in general,
welfare dominated by policies which target monetary aggregates. Crucially,
we find that fixed exchange rates are almost never optimal. On the other
hand, under some conditions, a non-state contingent rule like a fixed money
rule can even implement the first-best allocation.
Comments
JEL Classification: F1, F2. Length: 38 pages. Original Release Date: November 2012; Revision: June 1, 2017.