Document Type

Working Paper

Publication Date


Working Paper Number

WP #14006, March 2014


This paper studies the choice of monetary policy regime in a small open economy under productivity shocks and noise traders in forex markets. We focus on two simple rules: fixed exchange rates and inflation targeting. We contrast the above two rules against optimal policy with commitment. In general, the presence of noise traders increases the desirability of a fixed exchange rate regime. We also evaluate the welfare impact of Tobin taxes on capital flows. These taxes help unambiguously in the absence of productivity shocks; their welfare impact under productivity shocks depends on the monetary regime in place and the trade elasticity between domestic and foreign goods.

Publication Status

Under review.

JEL Classification

E42, E52, F41

File Format



15 pages

Included in

Economics Commons