Abstract: This paper studies the choice of monetary policy regime in a small open economy with noise traders in forex markets. We focus on two simple rules: fixed exchange rates and inflation targeting. We contrast the above two rules against optimal policy with commitment under productivity shocks. In general, the presence of noise traders increases the desirability of a fixed exchange rate regime. We also evaluate the welfare impact of Tobin taxes in this milieu. These taxes help unambiguously in the absence of productivity shocks; their welfare impact under productivity shocks depends on the monetary regime in place and trade elasticity between domestic and foreign goods.

Authors’ Name: Jong Kook Shin & Chetan Subramanian

URL: http://www.sciencedirect.com/science/article/pii/S0164070416300192

Journal: Journal of Macroeconomics

Volume, Issue, Page Numbers: Volume 49, September 2016, Pages 33–45