MONETARY POLICY AND INTERNATIONAL COMPETITIVENESS

Abstract

A model of Dornbusch is adapted to analyze the consequences for output and competitiveness of certain aspects of the U.K. government's medium term financial strategy and some other policy actions. This includes the announcement of a sequence of reductions in the target rate of monetary growth, an increase in VAT and a move to make the U.K. banking system more competitive. The impact of a discovery of domestic oil is also modeled. We consider the consequences of varying the degree of inertia in the underlying rate of inflation and of different rates of international capital mobility. A real interest rate equalization tax stabilizes the real exchange rate but not the level of output. Once and for all changes in the level of the nominal money stock to accommodate changes in the demand for real money balances prevent 'overshooting' of the real exchange rate and fluctuations in output. It may, however, undermine the credibility of an announced policy of monetary disinflation.

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