Economics Department
Working Papers in Economics
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TITLE:
Alternative Monetary Rules for a Small Open Economy: The Case of Canada
AUTHOR(S):
Fabio Ghironi, Boston College
DOCUMENT TYPE: Article
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ABSTRACT:
I compare the performance of alternative monetary rules for Canada using an open economy model under incomplete markets. Different rules generate different paths for the markup and the terms of trade. A comparison of welfare levels suggests that flexible inflation targeting, the Bank of Canadaęs current policy, dominates strict targeting rulesłamong which a fixed exchange rate with the U.S.łand the Taylor rule. In contrast to other studies, strict targeting rules generate a more stable real economy by stabilizing markup dynamics. Flexible inflation targeting dominates because it yields a positive covariance between consumption and the labor effort, which provides agents with a source of risk diversification.