Financial globalization and monetary policy

Recent data show substantial increases in the size of gross external asset and liabilitypositions. The implications of these developments for optimal conduct of monetarypolicy are analyzed in a standard open economy model which is augmented to allowfor endogenous portfolio choice. The model shows that monetary policy takes on newimportance due to its impact on nominal asset returns. Nevertheless, the case for pricestability as an optimal monetary rule remains. In fact, it is reinforced. Even withoutnominal price rigidities, price stability is optimal because it enhances the risk sharingproperties of nominal bonds.[...]