On Optimal Monetary Policy Rules and the Construction of MCIs in the Open Economy

This paper presents a simple open-economy forward-looking model to underscore the important role of the real exchange rate channel in the conduct of optimal monetary policy. As opposed to the closed economy, optimal monetary policy in the open economy depends on both demand-side and supply-side parameters. The paper also highlights the importance of the exchange rate channel for the design and implementation of a Monetary Conditions Index in the conduct of monetary policy. The model gives rise to an alternative MCI where the weight on the real exchange rate depends on all parameters of the model and the policymaker’s preferences. Copyright Springer Science + Business Media, Inc. 2005