Ramsey Monetary Policy and International Relative Prices
We analyze welfare maximizing monetary policy in a dynamic two-country model with price
stickiness and imperfect competition. In this context, a typical terms of trade externality affects policy competition between independent monetary authorities. Unlike the existing literature, we remain consistent to a public finance approach by an explicit consideration of all the distortions that are relevant to the Ramsey planner. This strategy entails two main advantages. First, it allows an exact characterization of optimal policy in an economy that evolves around a steadystate which is not necessarily efficient. Second, it allows to describe a full range of alternative dynamic equilibria when price setters in both countries are forward-looking and households’ preferences are not restricted. In this context, and in response to productivity shocks, deviations from price stability generally occur under Nash-competition. The size of such inefficiency is directlly related to parameters indexing openness, such as the elasticity of substitution between domestic and foreign goods and to the degree of home bias in consumption.