Optimal simple money rules in a small open economy with information uncertainty and measurement error

The central focus of this thesis is whether or not the exchange rate or some other dimension of the external side of the economy should form an integral part of the monetary rule of a small open economy (SOE) in which the central bank faces data deficiencies and individuals encounter measurement error. It does so in the context of a SOE model that features two of the most important empirical characteristics associated with SOEs---incomplete exchange rate pass-through and incomplete asset markets. After calibrating the implied dynamic stochastic general equilibrium (DSGE) model and deriving the loss function used by the monetary authority from the utility function of the representative household, I first examine what monetary policy rule would perform best if the monetary authority used the reaction coefficients that are typically adopted in the literature. Under a number of different information scenarios, the model's simulations suggest that the rule most often advocated for the closed economy case---the Taylor rule-- also works best for this SOE. The thesis then goes on to consider whether the Taylor rule continues to perform best when the reaction coefficients in the money rule are derived optimally. For the same information cases as discussed earlier, the model's simulations now indicate that some reflection of the external environment facing the SOE---either the real exchange rate gap and/or the law of one price gap---always will improve monetary policy performance. The significance of this is not just that external factors should form a part of a money rule but that policy makers should be careful in simply using coefficients that have been found helpful in other parts of the literature.;In the course of this discovery, the thesis also uncovers a number of other important regularities, suggesting, for example, an important information role for interest rate smoothing. In addition, the welfare gain from including interest rate smoothing and/or the real exchange rate or law of one price gap in the policy rule increases more in those cases where the monetary authority has less current and/or less reliable information. Finally we find that the introduction of measurement error (for both private agents and the monetary authority) leaves the ranking of optimal money rules unaltered while introducing a new feature--the optimal weight placed on indicators that can be observed only with noise is now smaller than otherwise.