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Title:Optimal monetary policy in a currency union: The role of the cost channel PDF Logo
Authors:Michaelis, Jochen
Issue Date:2012
Series/Report no.:Joint discussion paper series in economics 03-2012
Abstract:In this paper we introduce the cost channel of monetary policy (e.g., Ravenna and Walsh, 2006) into an otherwise standard New Keynesian model of a two-country monetary union, which is being hit by aggregate, asymmetric and idiosyncratic shocks. The single central bank implements the optimal discretionary monetary policy by setting the union interest rate.The cost channel makes monetary policy less effective in combatting inflation, but it is shown that the optimal response to the decline in effectiveness is a stronger use of the instrument. Moreover, we show how the sign of the spillover effects of idiosyncratic shocks depends on the strength of the cost channel. If the cost channel exceeds a well-defined threshold, then the interest rate turns into a supply-side instrument.
Subjects:cost channel
optimal monetary policy
monetary union
open economy macroeconomics
JEL:E31
E52
F41
Document Type:Working Paper
Appears in Collections:MAGKS Joint Discussion Paper Series in Economics, Universität Marburg

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