Competitive depreciation and the role of distorting taxes in an interdependent economy

This paper investigates the manners in which international cooperation in monetary policies affects the rate of inflation in a two-country sticky-price model. Within reasonable parameter values, international monetary coordination increases the steady-state inflation for given tax policies. When the tax regime is endogenously chosen, however, self-oriented monetary policies can engage in competitive depreciation and induce a higher average inflation than the first best inflation rate.