## 6. Flexible vs. Strict Domestic Inflation Targeting: Flexible Exchange Rate

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---

### I. Introduction and objective
- Purpose: develop a simple dynamic neo‑Keynesian model to analyze monetary policy with inflation targeting in a small open economy.
- Policy comparisons:
  - Flexible versus managed exchange rates.
  - Targeting the consumer price index (CPI) inflation versus domestic inflation.
  - Strict versus flexible inflation targeting.
- Evaluation criterion: minimization of output, inflation, and real exchange rate volatility and the resulting expected social loss.

### II. Model structure and mechanisms
- Framework: dynamic neo‑Keynesian (DNK) model for a small open economy with money, monopolistic competition, and Calvo (1983) sticky prices.
- Three structural blocks:
  - Aggregate demand: nontraditional IS curve (equation (16)) where the output gap depends on expected future output gap, the nominal interest rate, and nominal/real exchange rates.
  - Aggregate supply: forward‑looking Phillips‑type relation for domestic inflation (equation (17)).
  - Monetary sector: open‑economy Taylor‑type rule with interest rate smoothing (equations (20)–(22)) and an uncovered interest parity condition (equation (19)).
- Key definitions:
  - CPI: P_t = P_H,t^{γ} P_F,t^{1−γ} (log form equation (13)); CPI inflation π_t defined in equation (14).
  - Real exchange rate: Q_t = P_t / (S_t P*_t) (log approximation in equation (15)).
- Monetary policy rule (forecast‑based): i_t adjusts to expected inflation, current output gap, current exchange rate deviation, and lagged interest rate (equation (22)); χ_s = 0 corresponds to flexible exchange rate, χ_s > 0 to managed exchange rate.

### III. Calibration / key parameter values (selected)
- Discount factor: β = 0.99.
- Share of domestic goods in consumption: γ = 0.29.
- Calvo price stickiness: α = 0.75 (frequency of price adjustment: four quarters).
- Demand elasticity / monopolistic competition: θ = 4.33.
- Utility parameter: σ = 1 (log utility).
- Elasticity of substitution between domestic and foreign goods: η = 1.5.
- Interest rate smoothing: ρ_i = 0.7.
- Policy coefficient on inflation in baseline rule: χ_π = 1.5.
- Policy rule experiments: compare χ_x = 0.5 versus χ_x = 0.0 and χ_s = 0 versus χ_s = 3.34.
- Serial correlation parameters: ρ_r* = ρ_y* = ρ_z = ρ_ε = 0.8.
- Stochastic shock variances used in simulations: 2_r* = 0.25, 2_y* = 1, 2_z = 1, 2_ε = 0.25 (as specified for i.i.d. shocks).

### IV. Welfare criterion
- Social loss function (period loss): L_t = ψ_π π_{H,t}^2 + ψ_x x_t^2 + ψ_q q_t^2 (equation (27)).
- Benchmark weights used: ψ_π = 1.5; ψ_x = 0.5; ψ_q = 0.5.
- Evaluation: compare unconditional variances Var[π_{H,t}], Var[x_t], Var[q_t] and the resulting expected loss.

### V. Policy experiments and main quantitative results
- Shocks considered: foreign interest rate shock (r*_t), foreign output shock (y*_t), total factor productivity shock (z_t), domestic interest rate shock (ε_t). Each is AR(1) per equations (23)–(26).
- Foreign interest rate shock specification: a temporary increase of 25 basis points in the foreign nominal interest rate is considered in impulse responses; a negative foreign output shock with variance 3.76 is included when foreign interest rises (as noted in the simulations).

Findings — flexible versus managed exchange rates
- General result: flexible exchange rates dominate managed exchange rates when the economy is hit by foreign interest, foreign output, and productivity (real) shocks; managed exchange rates can be superior for nominal shocks.
- Mechanism: under flexible rates, exchange rate movements absorb shocks, reducing output volatility; under managed regimes, interest rates move more with foreign rates, transmitting volatility into real interest rates and output.
- Representative welfare comparisons (selected entries from Table 2: Welfare Loss):
  - Flexible CPI inflation targeting, Flexible exchange rate: 1.8722 (r*), 0.0229 (y*), 0.0347 (z), 2.9785 (ε).
  - Managed CPI inflation targeting, Managed exchange rate: 3.4804 (r*), 0.0601 (y*), 0.1578 (z), 0.0920 (ε).
  - Flexible domestic inflation targeting, Flexible exchange rate: 1.5876 (r*), 0.0229 (y*), 0.0345 (z), 2.5242 (ε).
  - Managed domestic inflation targeting, Managed exchange rate: 3.5089 (r*), 0.0602 (y*), 0.1581 (z), 0.0884 (ε).
- Interpretation: for foreign interest, output, and technology shocks the social loss numbers are lower under flexible exchange rates; for domestic interest rate shocks (ε) the managed exchange rate can produce much lower loss.

Findings — CPI inflation targeting versus domestic inflation targeting
- Key result: domestic inflation targeting generally outperforms CPI inflation targeting across shock types under flexible exchange rates.
- Intuition: targeting domestic inflation allows the exchange rate to adjust more freely, stabilizing output and domestic inflation at the cost of potentially higher real exchange rate variability; overall welfare (combining ψ_π, ψ_x, ψ_q) favors domestic inflation targeting.
- Numerical comparison (flexible exchange rate, flexible targeting):
  - Flexible CPI inflation targeting: 1.8722 (r*), 0.0229 (y*), 0.0347 (z), 2.9785 (ε).
  - Flexible domestic inflation targeting: 1.5876 (r*), 0.0229 (y*), 0.0345 (z), 2.5242 (ε).
- Note: under managed exchange rates, targeting CPI vs domestic inflation yields equivalent volatility because targeting CPI under managed rates effectively pins both domestic inflation and the exchange rate.

Findings — flexible inflation targeting versus strict inflation targeting
- Definitions:
  - Strict inflation targeting: inflation stabilization is the unique objective of the monetary authority.
  - Flexible inflation targeting: authority stabilizes inflation, output, and, if appropriate, the exchange rate.
- Results:
  - Flexible inflation targeting produces lower output volatility than strict inflation targeting across shocks.
  - Inflation outcomes are ambiguous and depend on shock type; for domestic interest rate shocks, flexible targeting dominates in inflation outcomes; for productivity shocks, flexible targeting can raise CPI and domestic inflation more than strict targeting because strict targeting uses the exchange rate channel to stabilize CPI, reducing real exchange rate movements.
- Welfare comparisons (selected entries from Table 2):
  - Strict CPI inflation targeting, Flexible exchange rate: 2.9837 (r*), 0.0642 (y*), 0.0964 (z), 96.6302 (ε).
  - Strict domestic inflation targeting, Flexible exchange rate: 1.4537 (r*), 0.0745 (y*), 0.0718 (z), 45.5737 (ε).
  - By contrast, flexible targeting cases show much lower losses for ε shocks (e.g., 2.9785 and 2.5242).
- Conclusion: flexible inflation targeting is superior in terms of aggregate social loss combining inflation, output, and real exchange rate volatility.

### VI. Supplemental numerical diagnostics (selected unconditional standard deviations)
- Foreign interest rate shock (Table A.1), Flexible CPI inflation targeting, Flexible exchange rate:
  - Output: 0.8466; Domestic inflation: 0.0957; CPI inflation: 0.6972; Real exchange rate: 2.4209; Nominal interest rate: 0.1419; Real interest rate: 0.7433.
- Foreign output shock (Table A.2), Flexible CPI inflation targeting, Flexible exchange rate:
  - Output: 0.0950; Domestic inflation: 0.0021; CPI inflation: 0.0429; Real exchange rate: 0.1657; Nominal interest rate: 0.0402; Real interest rate: 0.0513.
- Productivity shock (Table A.3), Flexible CPI inflation targeting, Flexible exchange rate:
  - Output: 0.1181; Domestic inflation: 0.1361; CPI inflation: 0.1341; Real exchange rate: 0.0577; Nominal interest rate: 0.0860; Real interest rate: 0.0944.
- Domestic interest rate shock (Table A.4), Flexible CPI inflation targeting, Flexible exchange rate:
  - Output: 4.4134; Domestic inflation: 0.3791; CPI inflation: 0.7371; Real exchange rate: 2.1553; Nominal interest rate: 0.2455; Real interest rate: 0.8113.

### VII. Robustness, caveats, and policy implications
- Robustness:
  - Results obtained via simulations for parameter values chosen to be consistent with Chilean estimates and standard literature; main qualitative conclusions are robust to reasonable parameter variations.
- Caveats:
  - Model assumes complete international markets (state‑contingent assets) and omits financial frictions (balance‑sheet effects, liability dollarization, borrowing constraints). These omitted features may affect quantitative rankings but earlier work suggests qualitative rankings can be similar.
  - Welfare is evaluated using a quadratic loss in inflation, output gap, and real exchange rate rather than direct aggregation from microfoundations of utility for all extensions.
- Policy implications:
  - Choice between flexible and managed exchange rate regimes should depend on the nature of shocks: flexible rates are preferable for real and foreign shocks; pegged/managed rates may be preferable for nominal shocks.
  - Domestic inflation targeting typically outperforms CPI targeting in small open economies with flexible exchange rates.
  - Flexible inflation targeting (stabilizing inflation and output) dominates strict inflation targeting (inflation only) in welfare terms because strict targeting can generate large output volatility.

*Source: _wp0421 - 6. Flexible vs. Strict Domestic Inflation Targeting: Flexible Exchange Rate, IMF Working Paper (excerpt).*

### References..............................................................................................................

### References................................................................................................................................34

### Tables
- 1. GMM Estimations of the Central Bank of Chile's Reaction Function ....................16
- 2. Welfare Loss ............................................................................................................21

### Appendix Tables
- A.1. Unconditional Standard Deviations: Foreign Interest Rate Shock ......................32
- A.2. Unconditional Standard Deviations: Foreign Output Shock................................32
- A.3. Unconditional Standard Deviations: Productivity Shock ....................................33
- A.4. Unconditional Standard Deviations: Domestic Interest Rate Shock ...................33

### Figures
- 1. Flexible vs. Managed Exchange Rate: Domestic Inflation Targeting .....................19
- 2. Flexible vs. Managed Exchange Rate: CPI Inflation Targeting ..............................20
- 3. CPI vs. Domestic Inflation Targeting: Flexible Exchange Rate..............................22
- 4. CPI vs. Domestic Inflation Targeting: Managed Exchange Rate ............................23
- 5. Flexible vs. Strict CPI Inflation Targeting: Flexible Exchange Rate ......................25

*Source: _wp0421 - References..............................................................................................................*

### 6. Flexible vs. Strict Domestic Inflation Targeting: Flexible Exchange Rate .............26

### 6. Flexible vs. Strict Domestic Inflation Targeting: Flexible Exchange Rate

### I. Introduction and objective
- Purpose: develop a simple dynamic neo‑Keynesian model to analyze monetary policy with inflation targeting in a small open economy.
- Policy comparisons:
  - Flexible versus managed exchange rates.
  - Targeting the consumer price index (CPI) inflation versus domestic inflation.
  - Strict versus flexible inflation targeting.
- Evaluation criterion: minimization of output, inflation, and real exchange rate volatility and the resulting expected social loss.

### II. Model structure and mechanisms
- Framework: dynamic neo‑Keynesian (DNK) model for a small open economy with money, monopolistic competition, and Calvo (1983) sticky prices.
- Three structural blocks:
  - Aggregate demand: a nontraditional IS curve (equation (16)) where the output gap depends on expected future output gap, the nominal interest rate, and nominal/real exchange rates.
  - Aggregate supply: forward‑looking Phillips‑type relation for domestic inflation (equation (17)).
  - Monetary sector: an open‑economy Taylor‑type rule with interest rate smoothing (equations (20)–(22)) and an uncovered interest parity condition (equation (19)).
- Key definitions:
  - CPI: P_t = P_H,t^{γ} P_F,t^{1−γ} (log form equation (13)); CPI inflation π_t defined in equation (14).
  - Real exchange rate: Q_t = P_t / (S_t P*_t) (log approximation in equation (15)).
- Monetary policy rule (forecast‑based): i_t adjusts to expected inflation, current output gap, current exchange rate deviation, and lagged interest rate (equation (22)); χ_s = 0 corresponds to flexible exchange rate, χ_s > 0 to managed exchange rate.

### III. Calibration / key parameter values (selected)
- Discount factor: β = 0.99.
- Share of domestic goods in consumption: γ = 0.29.
- Calvo price stickiness: α = 0.75 (frequency of price adjustment: four quarters).
- Demand elasticity / monopolistic competition: θ = 4.33.
- Utility parameter: σ = 1 (log utility).
- Elasticity of substitution between domestic and foreign goods: η = 1.5.
- Interest rate smoothing: ρ_i = 0.7.
- Policy coefficient on inflation in baseline rule: χ_π = 1.5.
- Policy rule experiments: compare χ_x = 0.5 versus χ_x = 0.0 and χ_s = 0 versus χ_s = 3.34.
- Serial correlation parameters: ρ_r* = ρ_y* = ρ_z = ρ_ε = 0.8.
- Stochastic shock variances used in simulations: 2_r* = 0.25, 2_y* = 1, 2_z = 1, 2_ε = 0.25 (as specified for i.i.d. shocks).

### IV. Welfare criterion
- Social loss function (period loss): L_t = ψ_π π_{H,t}^2 + ψ_x x_t^2 + ψ_q q_t^2 (equation (27)).
- Benchmark weights used: ψ_π = 1.5; ψ_x = 0.5; ψ_q = 0.5.
- Evaluation: compare unconditional variances Var[π_{H,t}], Var[x_t], Var[q_t] and the resulting expected loss.

### V. Policy experiments and main quantitative results
- Shocks considered: foreign interest rate shock (r*_t), foreign output shock (y*_t), total factor productivity shock (z_t), domestic interest rate shock (ε_t). Each is AR(1) per equations (23)–(26).
- Foreign interest rate shock specification: a temporary increase of 25 basis points in the foreign nominal interest rate is considered in impulse responses; a negative foreign output shock with variance 3.76 is included when foreign interest rises (as noted in the simulations).

Major findings (qualitative and numerical summaries):

- Flexible versus managed exchange rates
  - General result: flexible exchange rates dominate managed exchange rates when the economy is hit by foreign interest, foreign output, and productivity (real) shocks; managed exchange rates can be superior for nominal shocks.
  - Mechanism: under flexible rates, exchange rate movements absorb shocks, reducing output volatility; under managed (or pegged) regimes, interest rates move more with foreign rates, transmitting volatility into real interest rates and output.
  - Representative welfare comparisons (selected entries from Table 2: Welfare Loss):
    - Flexible CPI inflation targeting, Flexible exchange rate: 1.8722 (r*), 0.0229 (y*), 0.0347 (z), 2.9785 (ε).
    - Managed CPI inflation targeting, Managed exchange rate: 3.4804 (r*), 0.0601 (y*), 0.1578 (z), 0.0920 (ε).
    - Flexible domestic inflation targeting, Flexible exchange rate: 1.5876 (r*), 0.0229 (y*), 0.0345 (z), 2.5242 (ε).
    - Managed domestic inflation targeting, Managed exchange rate: 3.5089 (r*), 0.0602 (y*), 0.1581 (z), 0.0884 (ε).
  - Interpretation: for foreign interest, output, and technology shocks the social loss numbers are lower under flexible exchange rates; for domestic interest rate shocks (ε) the managed exchange rate can produce much lower loss (see the CPI strict cases below for extreme examples).

- CPI inflation targeting versus domestic inflation targeting
  - Key result: domestic inflation targeting generally outperforms CPI inflation targeting across shock types under flexible exchange rates.
  - Intuition: targeting domestic inflation allows the exchange rate to adjust more freely, stabilizing output and domestic inflation at the cost of potentially higher real exchange rate variability; overall welfare (combining ψ_π, ψ_x, ψ_q) favors domestic inflation targeting.
  - Numerical comparison from Table 2 (flexible exchange rate, flexible targeting):
    - Flexible CPI inflation targeting: welfare losses 1.8722 (r*), 0.0229 (y*), 0.0347 (z), 2.9785 (ε).
    - Flexible domestic inflation targeting: welfare losses 1.5876 (r*), 0.0229 (y*), 0.0345 (z), 2.5242 (ε).
  - Note: under managed exchange rates, targeting CPI vs domestic inflation yields equivalent volatility because targeting CPI under managed rates effectively pins both domestic inflation and the exchange rate.

- Flexible inflation targeting versus strict inflation targeting
  - Definitions:
    - Strict inflation targeting: inflation stabilization is the unique objective of the monetary authority.
    - Flexible inflation targeting: authority stabilizes inflation, output, and, if appropriate, the exchange rate.
  - Results:
    - Flexible inflation targeting produces lower output volatility than strict inflation targeting across shocks.
    - Inflation outcomes are ambiguous and depend on shock type; for domestic interest rate shocks, flexible targeting dominates in inflation outcomes; for productivity shocks, flexible targeting can raise CPI and domestic inflation more than strict targeting because strict targeting uses the exchange rate channel to stabilize CPI, reducing real exchange rate movements.
    - Welfare comparisons (selected entries from Table 2):
      - Strict CPI inflation targeting, Flexible exchange rate: 2.9837 (r*), 0.0642 (y*), 0.0964 (z), 96.6302 (ε).
      - Strict domestic inflation targeting, Flexible exchange rate: 1.4537 (r*), 0.0745 (y*), 0.0718 (z), 45.5737 (ε).
      - By contrast, flexible targeting cases (see above) show much lower losses for ε shocks (e.g., 2.9785 and 2.5242).
    - Conclusion: flexible inflation targeting is superior in terms of aggregate social loss combining inflation, output, and real exchange rate volatility.

### VI. Supplemental numerical diagnostics (selected unconditional standard deviations)
- Unconditional standard deviations reported for impulse responses (selected examples from Appendix II):
  - Foreign interest rate shock (Table A.1), Flexible CPI inflation targeting, Flexible exchange rate:
    - Output: 0.8466; Domestic inflation: 0.0957; CPI inflation: 0.6972; Real exchange rate: 2.4209; Nominal interest rate: 0.1419; Real interest rate: 0.7433.
  - Foreign output shock (Table A.2), Flexible CPI inflation targeting, Flexible exchange rate:
    - Output: 0.0950; Domestic inflation: 0.0021; CPI inflation: 0.0429; Real exchange rate: 0.1657; Nominal interest rate: 0.0402; Real interest rate: 0.0513.
  - Productivity shock (Table A.3), Flexible CPI inflation targeting, Flexible exchange rate:
    - Output: 0.1181; Domestic inflation: 0.1361; CPI inflation: 0.1341; Real exchange rate: 0.0577; Nominal interest rate: 0.0860; Real interest rate: 0.0944.
  - Domestic interest rate shock (Table A.4), Flexible CPI inflation targeting, Flexible exchange rate:
    - Output: 4.4134; Domestic inflation: 0.3791; CPI inflation: 0.7371; Real exchange rate: 2.1553; Nominal interest rate: 0.2455; Real interest rate: 0.8113.

### VII. Robustness, caveats, and policy implications
- Robustness:
  - Results obtained via simulations for parameter values chosen to be consistent with Chilean estimates and standard literature; main qualitative conclusions are robust to reasonable parameter variations.
- Caveats:
  - Model assumes complete international markets (state‑contingent assets) and omits financial frictions (balance‑sheet effects, liability dollarization, borrowing constraints). These omitted features may affect quantitative rankings but earlier work suggests qualitative rankings can be similar.
  - Welfare is evaluated using a quadratic loss in inflation, output gap, and real exchange rate rather than direct aggregation from microfoundations of utility for all extensions.
- Policy implications:
  - Choice between flexible and managed exchange rate regimes should depend on the nature of shocks: flexible rates are preferable for real and foreign shocks; pegged/managed rates may be preferable for nominal shocks.
  - Domestic inflation targeting typically outperforms CPI targeting in small open economies with flexible exchange rates.
  - Flexible inflation targeting (stabilizing inflation and output) dominates strict inflation targeting (inflation only) in welfare terms because strict targeting can generate large output volatility.

*Source: _wp0421 - 6. Flexible vs. Strict Domestic Inflation Targeting: Flexible Exchange Rate, IMF Working Paper (excerpt).*

### REFERENCES

### _wp0421 - REFERENCES

### Monetary policy rules
- Ball, Lawrence, 1999, “Policy Rules for Open Economies,” in Monetary Policy Rules, ed. by J. Taylor (Chicago, Illinois: University of Chicago Press).
- Batini, Nicoletta, and Andrew G. Haldane, 1998, “Forward-Looking Rules for Monetary Policy,” NBER Working Paper No. 6543 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Clarida, Richard, Jordi Galí, and Mark Gertler, 1998, “Monetary Policy Rules in Practice: Some International Evidence,” European Economic Review, Vol. 42, No. 6, pp. 1033–68.
- Clarida, Richard, Jordi Galí, and Mark Gertler, 1999, “The Science of Monetary Policy: A New Keynesian Perspective,” Journal of Economic Literature, Vol. 37, No. 4, pp. 1661–707.
- Clarida, Richard, Jordi Galí, and Mark Gertler, 2000, “Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory,” Quarterly Journal of Economics, Vol. 115, No. 1, pp. 147–80.
- McCallum, Bennett T., and Edward Nelson, 1999, “Nominal Income Targeting in an Open-Economy Optimizing Model,” Journal of Monetary Economics, Vol. 43, No. 3, pp. 553–78.
- Poole, 1970, “Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model,” Quarterly Journal of Economics, Vol. 84, No. 2, pp. 197-216.
- Rotemberg, Julio J., and Michael Woodford, 1998b, “Interest-Rate Rules in an Estimated Sticky Price Model,” in Monetary Policy Rules, ed. by John B. Taylor (Chicago, Illinois: University of Chicago Press), pp. 57–119.
- Rotemberg, Julio J., and Michael Woodford, 1998a, “An Optimization Based Econometric Framework for the Evaluation of Monetary Policy,” in NBER Macroeconomics Annual 1997, ed. by Ben S. Bernanke and Julio J. Rotemberg (Cambridge, Massachusetts: MIT Press), pp. 297–346.

### Inflation targeting and price stability
- Bernanke, Ben, Thomas Laubach, Frederick Mishkin, and Adam Posen, 1999, “Inflation Targeting: Lessons from the International Experience.” (Princeton, New Jersey: Princeton University Press).
- Jadresic, Esteban, 1999, “Inflation Targeting and Output Stability,” IMF Working Paper 99/61 (Washington: International Monetary Fund).
- King, Robert, and Alexander Wolman, 1996, “Inflation Targeting in a St. Louis Model of the 21st Century,” Federal Reserve Bank of St. Louis Review, Vol. 78, No. 3, pp. 83–107.
- Masson, Paul, Miguel A. Savastano, and Sunil Sharma, 1997, “The Scope for Inflation Targeting in Developing Countries,” IMF Working Paper 97/130 (Washington: International Monetary Fund).
- Svensson, Lars E.O., 1999, “Inflation Targeting as a Monetary Policy Rule,” Journal of Monetary Economics, Vol. 43, No. 3, pp. 607-654.
- Svensson, Lars E.O., 2000, “Open Economy Inflation Targeting,” Journal of International Economics, Vol. 50, No. 1, pp. 155–83.
- Morandé, Felipe, 2001, “Una Década de Metas de Inflación en Chile: Desarrollos, Lecciones y Desafíos,” Economía Chilena, Vol. 4, No. 1, pp. 35–62.

### Open economy macroeconomics and exchange rates
- Ball, Lawrence, 1999, “Policy Rules for Open Economies,” in Monetary Policy Rules, ed. by J. Taylor (Chicago, Illinois: University of Chicago Press).
- Benigno, Pierpaolo, 2000, “Optimal Monetary Policy in a Currency Area” (unpublished; Princeton, New Jersey: Princeton University).
- Benigno, Pierpaolo, and Gianluca Benigno, 2001, “Price Stability in Open Economies” (unpublished; New York: New York University).
- Céspedes, Luis Felipe, Roberto Chang, and Andrés Velasco, 2000, “Balance Sheets and Exchange Rate Policy,” NBER Working Paper 7840 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Chang, Roberto, and Andrés Velasco, 2000, “Liquidity Crises in Emerging Markets,” NBER Working Paper 7272 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Flood, Robert, 1979, “Capital Mobility and the Choice of Exchange Rate System,” International Economic Review, Vol. 20, No. 2, pp. 405–16.
- Galí, Jordi, and Tommaso Monacelli, 2002, “Optimal Monetary Policy and Exchange Rate Volatility in a Small Open Economy” (unpublished; Chestnut Hill, Massachusetts: Department of Economics, Boston College).
- Lane, Philip R., 2001, “The New Open Economy Macroeconomics: A Survey,” Journal of International Economics, Vol. 54, No. 2, pp. 235–66.
- Obstfeld, Maurice, and Kenneth Rogoff, 1995, “Exchange Rate Dynamics Redux,” Journal of Political Economy, Vol. 103, No. 3, pp. 624–60.
- Svensson, Lars E.O., 2000, “Open Economy Inflation Targeting,” Journal of International Economics, Vol. 50, No. 1, pp. 155–83.

### Models, methodology, and theoretical foundations
- Bernanke, Ben, Mark Gertler, and Simon Gilchrist, 1999, “The Financial Accelerator in a Quantitative Business Cycle Framework,” in Handbook of Macroeconomics, ed. by J. Taylor and M. Woodford (Amsterdam: North-Holland).
- Blanchard, Olivier, and Charles Kahn, 1980, “The Solution of Linear Difference Models under Rational Expectations,” Econometrica, Vol. 48, No. 5, pp. 1305–11.
- Calvo, Guillermo, 1983, “Staggered Prices in a Utility-Maximizing Framework,” Journal of Monetary Economics, Vol. 12, No. 3, pp. 383–98.
- Dixit, Avinash K., and Joseph E. Stiglitz, 1977, “Monopolistic Competition and Optimum Product Diversity,” American Economic Review, Vol. 67, No. 3, pp. 297–308.
- Goodfriend, Marvin, and Robert G. King, 1997, “The New Neoclassical Synthesis,” in NBER Macroeconomics Annual, ed. by B. Bernanke and J. Rotemberg (Cambridge: MIT Press).
- Poole, 1970, “Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model,” Quarterly Journal of Economics, Vol. 84, No. 2, pp. 197-216.
- Rotemberg, Julio J., and Michael Woodford, 1998a, “An Optimization Based Econometric Framework for the Evaluation of Monetary Policy,” in NBER Macroeconomics Annual 1997, ed. by Ben S. Bernanke and Julio J. Rotemberg (Cambridge, Massachusetts: MIT Press), pp. 297–346.
- Woodford, Michael, 1996, “Control of the Public Debt: A Requirement for Price Stability,” NBER Working Paper 5684 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Woodford, Michael, 1999, “Optimal Monetary Policy Inertia,” NBER Working Paper 7261 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Woodford, Michael, 2001, “Inflation Stabilization and Welfare,” NBER Working Paper 8071 (Cambridge, Massachusetts: National Bureau of Economic Research).

### Emerging markets and policy applications
- Ghironi, Fabio, and Alessandro Rebucci, 2001, “Monetary Rules for Emerging Market Economies,” Working Paper 476, Economics Department, Boston College.
- Masson, Paul, Miguel A. Savastano, and Sunil Sharma, 1997, “The Scope for Inflation Targeting in Developing Countries,” IMF Working Paper 97/130 (Washington: International Monetary Fund).
- Monacelli, Tommaso, 2000, “Relinquishing Monetary Independence” (unpublished; Chestnut Hill, Massachusetts: Department of Economics, Boston College).
- Parrado, Eric, 2000, “Monetary Policy Rules in a Small Open Economy: The Case of Chile” (unpublished; New York: New York University).
- Parrado, Eric, and Andrés Velasco, 2002, “Optimal Interest Rate Policy in a Small Open Economy,” NBER Working Paper No. 8721 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Céspedes, Luis Felipe, Roberto Chang, and Andrés Velasco, 2000, “Balance Sheets and Exchange Rate Policy,” NBER Working Paper 7840 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Chang, Roberto, and Andrés Velasco, 2000, “Liquidity Crises in Emerging Markets,” NBER Working Paper 7272 (Cambridge, Massachusetts: National Bureau of Economic Research).

*Source: _wp0421 - REFERENCES*

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