Optimal monetary policy with an interest-equalization tax in a two-country macroeconomic model

This paper examines the coordination of monetary policy and an interest-equalization tax stabilizer within a two-country macroeconomic model. Within this two-country framework, which allows for wage indexation and includes an imported intermediate good, monetary policy is shown to be severely constrained by the uncovered interest parity condition implied by perfect capital mobility. Introduction of an interest-equalization tax stabilizer into the model significantly enhances policy makers' ability to stabilize output (or price) in the two countries.