Optimal Monetary Policy in a Small Open Economy Under Segmented Asset Markets and Sticky Prices

Author/Editor:

Juan Pablo Medina Guzman ; Ruy Lama

Publication Date:

September 1, 2007

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

This paper studies optimal monetary policy in a two-sector small open economy model under segmented asset markets and sticky prices. We solve the Ramsey problem under full commitment, and characterize the optimal monetary policy in a calibrated version of the model. The findings of the paper are threefold. First, the Ramsey solution mimics the allocations under flexible prices. Second, under the optimal policy the volatility of non-tradable inflation is close to zero. Third, stabilizing nontradable inflation is optimal regardless of the financial structure of the small open economy. Even for a moderate degree of price stickiness, implementing a monetary policy that mitigates asset market segmentation is highly distortionary. This last result suggests that policymakers should resort to other policy instruments in order to correct financial imperfections.

Series:

Working Paper No. 07/217

Subject:

English

Publication Date:

September 1, 2007

ISBN/ISSN:

9781451867817/1018-5941

Stock No:

WPIEA2007217

Format:

Paper

Pages:

55

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