In stochastic models of large open economies with heterogeneous households and incomplete markets, the monetary policies of central banks have real effects. This paper considers a pure exchange economy with heterogeneous households and incomplete markets and central bank policy that targets both the short-term nominal interest rate and the exchange rates. The paper proves that inflation rate targeting and nominal GDP targeting policies are incompatible with Pareto efficiency (generically), and characterizes necessary conditions under which more general policies are compatible with Pareto efficiency.
Previously circulated as "Optimal monetary policy in open economies with incomplete markets."
Please cite as:
Hoelle, M. (2014): "Optimal monetary policy in open economies with incomplete markets," Krannert Working Paper Series, Paper No. 1279.