Alternative Monetary Rules for a Small Open Economy
Ghironi, Fabio. “Alternative Monetary Rules for a Small Open Economy”. Boston College Working Papers in Economics 466, 2000.
I compare the performance of alternative monetary rules for Canada using an open economy model under incomplete markets. Different rules generate different paths for the markup and the terms of trade. A comparison of welfare levels suggests that flexible inflation targeting, the Bank of CanadaÃs current policy, dominates strict targeting rulesâ¥among which a fixed exchange rate with the U.S.â¥and the Taylor rule. In contrast to other studies, strict targeting rules generate a more stable real economy by stabilizing markup dynamics. Flexible inflation targeting dominates because it yields a positive covariance between consumption and the labor effort, which provides agents with a source of risk diversification.