The Optimal Monetary Policy in a Two-Country DSGE Model

The purpose of this paper is to investigate the optimal monetary policy in the context of a two-country model. I have incorporated the dynamic stochastic general equilibrium model. The main conclusions are summaries as follows. First, using bayesian estimation technic with Korea data, the estimated parameters are in the range of reasonable interpretation. Second, based on estimated parameters, the impulse response analysis has been implemented for the technology, cost-push and foreign income shocks. When there is a one standard deviation of technology shock, the output gap decreases as the output under flexible price increases. However, the output decreases since the central bank decreases the nominal interest rate to keep the output gap on the long-run equilibrium. The domestic and CPI inflation decrease as the total supply exceeds its long-run equilibrium. Third, social welfare loss analysis shows that the SDIT and FDIT are optimal in the sense that those alternative simple interest rate rules minimize the social welfare loss evaluated by the domestic inflation and output gap. The exchange rate peg, however, is suboptimal even though it stabilize the volatility of exchange rate.