Optimal monetary policy in the presence of pricing-to-market

This paper presents a general-equilibrium framework to revisit the issues of optimal monetary policies and international policy coordination in a two-country model, focusing on the role of a pricing-to-market (PTM) policy by firms. Both countries may be different with respect to PTM. Using the set-up developed by Corsetti and Pesenti (2001a) and Betts and Devereux (2000a,b), we show that (i) for a given Foreign monetary stance, a Home monetary expansion is beneficial for both countries only if Home PTM is at an intermediate range; (ii) in a world Nash equilibrium Home and Foreign welfare are bell-shaped in the degrees of PTM; (iii) relative welfare crucially depends on the degrees of PTM; (iv) there is a welfare gain from cooperation even in the cases of no and full PTM.