Current account dynamics and optimal monetary policy in a small-open economy

Abstract

This paper studies a small open economy with two sectors. In a perfect foresight, rational expectation general equilibrium model, with sticky prices in the non-traded goods sector, the current account responses to monetary shocks depend on the elasticity of substitution between consumption and risk aversion, the country's initial net foreign asset position, and the degree of monopolistic competition. The current account reacts quite efficiently to technological shocks in a small open economy. The welfare gain for households from adopting optimal monetary policy in contrast to constant money growth rule is quantitatively small.