Editing Monetary policy (section)

==Contexts==

===In international economics===
Optimal monetary policy in [[international economics]] is concerned with the question of how monetary policy should be conducted in interdependent open economies. The [[neoclassical economics|classical view]] holds that international macroeconomic interdependence is only relevant if it affects domestic [[output gap]]s and inflation, and monetary policy prescriptions can abstract from openness without harm.<ref>{{cite journal |doi=10.1016/S0304-3932(02)00128-9 |title=A simple framework for international monetary policy analysis |journal=Journal of Monetary Economics |volume=49 |issue=5 |pages=879–904 |year=2002 |last1=Clarida |first1=Richard |last2=Galı́ |first2=Jordi |last3=Gertler |first3=Mark |citeseerx=10.1.1.591.9773 |s2cid=12773105 }}</ref> This view rests on two implicit assumptions: a high responsiveness of import prices to the exchange rate, i.e. producer currency pricing (PCP), and frictionless international financial markets supporting the efficiency of flexible price allocation.<ref name="Corsetti, G. 2005 pp. 281-305">Corsetti, G., Pesenti, P. (2005). International dimensions of optimal monetary policy. ''Journal of Monetary Economics'', 52(2), pp. 281–305.</ref><ref>{{cite journal |doi=10.1111/1467-937X.00266 |title=Monetary Policy in the Open Economy Revisited: Price Setting and Exchange-Rate Flexibility |journal=Review of Economic Studies |volume=70 |issue=4 |pages=765–783 |year=2003 |last1=Devereux |first1=Michael B. |last2=Engel |first2=Charles |citeseerx=10.1.1.34.3478 |s2cid=155988246 }}</ref> The violation or distortion of these assumptions found in empirical research is the subject of a substantial part of the international optimal monetary policy literature. The policy trade-offs specific to this international perspective are threefold:<ref name="corsettidedolaleduc">{{cite book |doi=10.1016/B978-0-444-53454-5.00004-9 |title=Optimal Monetary Policy in Open Economies |volume=3 |pages=861–933 |series=Handbook of Monetary Economics |year=2010 |last1=Corsetti |first1=Giancarlo |last2=Dedola |first2=Luca |last3=Leduc |first3=Sylvain |isbn=9780444534705 |hdl=1814/14555 |s2cid=17023845 |url=http://www.frbsf.org/publications/economics/papers/2010/wp10-13bk.pdf }}</ref>

First, research suggests only a weak reflection of exchange rate movements in import prices, lending credibility to the opposed theory of local currency pricing (LCP).<ref>{{cite journal |doi=10.1162/qjec.2008.123.2.531 |title=Sticky Borders |journal=Quarterly Journal of Economics |volume=123 |issue=2 |pages=531–575 |year=2008 |last1=Gopinath |first1=Gita |last2=Rigobon |first2=Roberto }}</ref> The consequence is a departure from the classical view in the form of a trade-off between output gaps and misalignments in international relative prices, shifting monetary policy to CPI inflation control and real exchange rate stabilization.

Second, another specificity of international optimal monetary policy is the issue of strategic interactions and competitive devaluations, which is due to cross-border spillovers in quantities and prices.<ref>{{cite book |doi=10.1016/S1573-4404(05)80018-8 |title=Double-edged incentives: Institutions and policy coordination |volume=3 |pages=1973–2030 |series=Handbook of International Economics |year=1995 |last1=Persson |first1=Torsten |last2=Tabellini |first2=Guido |isbn=9780444815477 }}</ref> Therein, the national authorities of different countries face incentives to manipulate the [[terms of trade]] to increase national welfare in the absence of international policy coordination. Even though the gains of international policy coordination might be small, such gains may become very relevant if balanced against incentives for international noncooperation.<ref name="Corsetti, G. 2005 pp. 281-305"/>

Third, open economies face policy trade-offs if asset market distortions prevent global efficient allocation. Even though the real exchange rate absorbs shocks in current and expected fundamentals, its adjustment does not necessarily result in a desirable allocation and may even exacerbate the misallocation of consumption and employment at both the domestic and global level. This is because, relative to the case of complete markets, both the Phillips curve and the loss function include a welfare-relevant measure of cross-country imbalances. Consequently, this results in domestic goals, e.g. [[output gap]]s or inflation, being traded-off against the stabilization of external variables such as the terms of trade or the demand gap. Hence, the optimal monetary policy in this case consists of redressing demand imbalances and/or correcting international relative prices at the cost of some inflation.<ref>{{cite web |url=https://www.snb.ch/n/mmr/reference/sem_2011_09_23_dedola/source/sem_2011_09_23_dedola.n.pdf |first1=Giancarlo |last1=Corsetti |first2=Luca |last2=Dedola |first3=Sylvain |last3=Leduc |date=September 2011 |title=Demand Imbalances, Exchange Rate Misalignments and Monetary Policy }}{{self-published source|date=February 2019}}</ref>{{self-published inline|date=February 2019}}

Corsetti, Dedola and Leduc (2011)<ref name="corsettidedolaleduc"/> summarize the status quo of research on international monetary policy prescriptions: "Optimal monetary policy thus should target a combination of inward-looking variables such as output gap and inflation, with currency misalignment and cross-country demand misallocation, by leaning against the wind of misaligned exchange rates and international imbalances." This is main factor in country money status.

===In developing countries===
Developing countries may have problems establishing an effective operating monetary policy. The primary difficulty is that few developing countries have deep markets in government debt. The matter is further complicated by the difficulties in forecasting money demand and fiscal pressure to levy the inflation tax by expanding the base rapidly. In general, the central banks in many developing countries have poor records in managing monetary policy. This is often because the monetary authorities in developing countries are mostly not independent of the government, so good monetary policy takes a backseat to the political desires of the government or is used to pursue other non-monetary goals. For this and other reasons, developing countries that want to establish credible monetary policy may institute a currency board or adopt [[dollarization]]. This can avoid interference from the government and may lead to the adoption of monetary policy as carried out in the anchor nation. Recent attempts at liberalizing and reform of financial markets (particularly the recapitalization of banks and other financial institutions in Nigeria and elsewhere) are gradually providing the latitude required to implement monetary policy frameworks by the relevant central banks.