Monetary Policy Trade-offs in the Open Economy

Recent work on monetary policy has focused on the trade-off between output volatility and inflation volatility. This literature is based largely on models of closed economies. Three conclusions about optimal policy characterize these models. First, the central bank faces an inflation-output gap volatility trade-off only in the presence of cost-push shocks. Second, aggregate demand shocks should be completely stabilized. Third, even in the absence of any under discretionary policy, there are still gains from commitment (or a conservative central banker), but these gains depend on the serial correlation properties of the cost-push shock only. In this paper, I show that none of these results carry over to the open economy.