Revisiting the Costs of Self-Oriented National Monetary Rules∗

The gains from international monetary policy cooperation are sizeable when the crossborder spillovers of shocks are significant and policymakers face a strong incentive to use monetary policy to insulate their country from these spillovers. We show that financial market arrangements play an integral role in determining these incentives. In a quantitative two-countries, two-goods model with sticky prices and wages, we find large costs of departing from cooperative policies when financial markets are complete and there is sufficient substitutability between the home and the foreign traded goods. By contrast, under incomplete financial markets, large costs arise when the home and the foreign goods are sufficiently complementary. JEL classifications: E44, E61, F42.