Optimal monetary policy minimizes unemployment and maximizes welfare in small economies.
The optimal monetary policy in a small open economy with unemployment aims to minimize variance in domestic price inflation, wage inflation, and the output gap. Stabilizing the unemployment rate is crucial for reducing welfare loss from technology and labor supply shocks. Introducing the unemployment rate into interest rate rules can enhance welfare. When not responding to unemployment, controlling CPI inflation is best, but once unemployment is controlled, the power of CPI inflation-based rules diminishes.