Alternative monetary rules in the open-economy: a welfare-based approach
How do central banks choose among alternative monetary polocies? In this paper we analyze that question for an open economy following an interest rate rule. Many issues remain controversial in the design of such a rule. If inflation is targeted, as it presumably is, should the domestic interest rate also react to the output gap or to movements in other real variables? Should inflation targeting focus on the consumer price index (CPI), on home prices only, or on some other index? Should the interest rate respond to movements in the nominal exchange rate? Equivalently, should the exchange rate float cleanly?