The paper extends previous analysis of closed-economy inflation targeting to a small open economy with forward-looking aggregate supply and demand with some microfoundations, and with stylized realistic lags in the different transmission channels for monetary policy. The paper compares targeting

in open economies

January 1998. I am grateful for research assistance from Qiming Chen,

open versus the closed economy? Is “potential GDP ” a function of global developments, or only of domestic resources available and domestic pro-ductivity? Perhaps most important, how—if at all—does openness influ-ence the optimalmonetary policy rule? Is a Taylor rule the rightmonetary policy

We lay out a small open economy version of the Calvo sticky price model, and show how the equilibrium dynamics can be reduced to a tractable canonical system in domestic inflation and the output gap. We employ this framework to analyze the macroeconomic implications of three alternative rule

This paper extends the savers-spenders theory of Mankiw (2000) to analyze fiscal policy in a small open economy with endogenous labor supply. It is first shown that tax cuts have a shortrun contractionary effect on domestic production, and increased public spending has a short-run expansionary

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What policy rules should central banks follow? A growing number of econo-mists and policymakers advocate targets for the level of inflation. Many also argue that inflation targeting should be implemented through a “Taylor rule” in which interest rates are adjusted in response to output and inflation. These

This paper studies the conditions under which price stability is the optimal policy in a two-country open-economy model with imperfect competition and price stickiness. Special conditions on the levels of country-specific distortionary taxation and the intratemporal and intertemporal elasticities

and Bruce Preston for valuable comments and discussions. The views expressed