Optimal monetary policy in the presence of pricing-to-market

This paper presents a general-equilibrium framework to revisit the issues of optimal monetary policies and international policy coordination in a two-country model, focusing on the role of a pricing-to-market (PTM) policy by firms. Both countries may be different with respect to PTM. Using the set-up developed by Corsetti and Pesenti [Corsetti, G., Pesenti, P., 2001. Welfare and macroeconomic interdependence. Quarterly Journal of Economics 116, 421-445] and Betts and Devereux [Betts, C., Devereux, M., 2000a. International monetary policy coordination and competitive depreciation: A reevaluation. Journal of Money, Credit, and Banking 32, 722-745; Betts, C., Devereux, M., 2000b. Exchange rate dynamics in a model of pricing-to-market. Journal of International Economics 50, 215-244], we show that (i) for a given Foreign monetary stance, a Home monetary expansion is beneficial for both countries only if Home PTM is at an intermediate range; (ii) in a world Nash equilibrium Home and Foreign welfare are bell-shaped in the degrees of PTM; (iii) relative welfare crucially depends on the degrees of PTM; (iv) there is a welfare gain from cooperation even in the cases of no and full PTM.