Optimal monetary policy for a small open economy

This paper focuses on the design of monetary policy rules for a small open economy. The model features optimizing behavior, general equilibrium and price stickiness. The real exchange rate is shown to affect the firm's real marginal cost, aggregate supply and aggregate demand. The welfare objective depends on the openness of the economy, and the optimal policy rule differs from that which obtains in a closed economy. The inflation versus output gap stabilization trade-off is caused by the real exchange rate. The implied optimal monetary policy regime is domestic inflation target coupled with controlled floating of the real exchange rate.     

The Simple Post-Keynesian Monetary Policy Model: An Open Economy Approach

Monetary policy with an inflation targeting rule is analyzed through a simple small-scale Post-Keynesian model that incorporates open economy issues. In contrast with previous Post-Keynesian attempts, the model embodies policy authorities that are committed not only to hitting inflation and/or output targets, but also to the achievement of the external balance. To take account of the external balance objective, we model the real exchange rate as an endogenous and moving target, with the nominal exchange rate being the instrument of that target. The model shows that in response to an adverse external shock the central bank has to consider first the required real exchange rate adjustment that will preserve the external balance, and secondly the level at which the interest rate must be set in order to maintain inflation stabilization. Keeping inflation to target requires higher interest rates and strong reliance on the unemployment channel which, under certain circumstances, also has adverse side effects on income distribution. We show that to deal with an exogenous external shock a policy mix of real exchange rate targeting and income distribution targeting outperforms inflation targeting.     

Monetary transmission mechanisms in a small open economy: a Bayesian structural VAR approach

Abstract This paper develops a Bayesian structural VAR model for Canada in order to estimate the effects of monetary policy shocks, using the overnight rate target as the policy instrument. I allow the policy variable and other home and foreign variables to interact with each other contemporaneously. The key finding is that monetary policy affects the real economy through both the market interest rate and the exchange rate. I also find that the Bank of Canada responds to any home and foreign variables that embodies information about future inflation and that external shocks are an important source of output fluctuations.     

Investment and interest rate policy: a discrete time analysis

This paper analyzes the restrictions necessary to ensure that the interest rate policy rule used by the central bank does not introduce local real indeterminacy into the economy. It conducts the analysis in a Calvo-style sticky price model. A key innovation is to add investment spending to the analysis. In this environment, local real indeterminacy is much more likely. In particular, all forward-looking interest rate rules are subject to real indeterminacy.     

Evaluating inflation targeting as a monetary policy objective for India

This study formulates a small open economy model for India with exchange rate as a prominent channel of monetary policy. The model is estimated using the Instrumental Variable-Generalized Methods of Moments (IV-GMM) estimator and evaluated through simulations. This study compares different cases of domestic and CPI inflation targeting, strict and flexible inflation targeting, and simple Taylor type rules. The analysis highlights the unsuitability of simple Taylor-type monetary rules in stabilizing the Indian economy and suggests that discretionary optimization works better in stabilizing this economy. There seems to be a trade-off between output gap stabilization and exchange rate stabilization in flexible domestic inflation targeting and CPI inflation targeting respectively. However, flexible domestic inflation targeting seems a better alternative from an overall macro stabilization perspective in India where financial markets are still not sufficiently integrated to ensure quick transmission of interest rate impulses and existence of rigidities in the economy.     

Exchange rate movements and monetary policy in Brazil: Econometric and simulation evidence

The literature on monetary economy has aroused growing interest in macroeconomics. Due to computational advancements, models have become increasingly more complex and accurate, allowing for an in-depth analysis of the relationships between real economic variables and nominal variables. Therefore, using a dynamic stochastic general equilibrium (DSGE) model, based on Gali and Monacelli (2005), we propose and estimate a model for the Brazilian economy by employing Bayesian methods so as to assess whether the Central Bank of Brazil takes exchange rate fluctuations into account in the conduct of monetary policy. The most striking result of the present study is that the Central Bank of Brazil does not directly change the interest rate path due to exchange rate movements. A simulation exercise is also used. Our conclusion is that the economy quickly accommodates shocks induced separately on the exchange rate, on the terms of trade, interest rate, and global inflation.     

Monetary policy in open economies

The recent literature on monetary policy in open economies has produced a strong presumption in favor of activistic policy and flexible exchange rates. We argue that this result may owe much to the combination of two commonly made assumptions: That nominal goods prices are rigid. And that the monetary authorities have a lot of information about the economy. When the source of nominal rigidity is found in wages and monetary policy is conducted according to less information demanding rules (such as a standard interest rate rule) policies that stabilize the money supply or the nominal exchange rate may perform better.     

TAYLOR RULE REACTION COEFFICIENTS AND REAL EXCHANGE RATE PERSISTENCE

Recent literature has established a link between the persistence of real exchange rates and the degree of inertia in Taylor rule monetary policy reactions functions. This paper provides a different view on this link by investigating how the size of Taylor rule reaction coefficients impacts the adjustment dynamics of the real exchange rate. Within a stylized sticky‐price open‐economy macro model, it is demonstrated that a stronger interest rate reaction to inflation in the Taylor rule raises the convergence speed of the real exchange rate. Conversely, raising the coefficient on the output gap or attending to the exchange rate in an open‐economy version of the Taylor rule slows down real exchange rate adjustment. In all cases, more rapid convergence comes at the cost of stronger initial real exchange rate misalignments in the wake of monetary policy shocks.     

钉住汇率下中国利率政策的困境:理论与经验

中国利率政策的行为表明,钉住汇率下的独立性是以利率政策的有效性损失为代价。处于对内通货膨胀高涨与对外巨额顺差并存的经济状态下,以单一利率政策应对开放经济的内外平衡目标,显然力不从心。在中国经济日益开放的当今,宏观经济调控需要新的政策工具,或是对既有政策工具赋予新的运用方法。     

Monetary policy rules for financially vulnerable economies

One distinguishable characteristic of emerging market economies is that they are not financially robust. These economies are incapable of smoothing out large external shocks, as sudden capital outflows imply abrupt swings in the real exchange rate. Using a small open-economy model, this paper examines alternative monetary policy rules for economies with different degrees of liability dollarization. The paper answers the question of how efficient it is to use inflation targeting (IT) under high liability dollarization. Our findings suggest that it might be optimal to follow a nonlinear policy rule that defends the real exchange rate in a financially vulnerable economy.     

Monetary Policy Rules for a Small Open Economy

In this paper, the optimal choice of a monetary target is investigated for a small open economy that is subject to foreign monetary policy shocks. In contrast to large parts of the literature, pegging the exchange rate is never the best policy choice for the small open economy in our model. Instead, monetary targeting and, depending on the parameter combination, producer price index targeting come closest to the optimal policy rule in terms of welfare. Generally, the welfare performance of the simple targeting rules under consideration hinge critically on the degree of pass-through in the home economy and in the rest of the world.     

Disinflation costs in China and monetary policy regimes

This paper investigates the real effects of a disinflationary policy in China, in which we conduct a disinflation experiment in a medium-scale New Keynesian model. We highlight two key features of China's economy: the relevance of money to monetary policy rules and household inequality. For the former, we consider two monetary policy regimes: an expanded Taylor rule with money and a money supply rule. For the latter, we take into account a share of the population that is limited in its ability to participate in assets markets. Our analysis suggests that a disinflation policy is more costly when the central bank controls the money supply than the case in which the nominal interest rate is the policy instrument. Our results are driven by the different impacts of disinflation on nominal and real interest rates under the two regimes.     

Capital Inflows,Dutch Disease Effects,and Monetary Policy in a Small Open Economy

This paper studies the role of monetary policy in a small open economy that experiences Dutch disease effects as a result of capital inflows, and examines the issue of whether such a policy should seek to address these effects from a welfare perspective. I find that Dutch disease effects occur under a fixed nominal exchange rate regime. However, a monetary policy regime characterized by generalized Taylor interest rate rules featuring either the real exchange rate or the nominal exchange rate avert Dutch disease effects. Welfare results reveal that the optimal rule is a generalized Taylor rule consistent with nominal exchange rate flexibility.     

Government‐spending multipliers and the zero lower bound in an open economy

This paper assesses the size of the government‐spending multiplier in an open economy when the zero lower bound (ZLB) on the nominal interest rate is binding. In a theoretical framework, in a closed economy, other authors have shown that when the nominal interest rate is binding the government‐spending multiplier can be very large (close to four). Their theory helps illuminate the government‐spending multiplier in the ZLB, but it is difficult to match that theory with the data. We argue that, in an open economy, another channel exists for the crowding‐out effect via the real exchange rate. For an open economy, the government‐spending multiplier is not large owing to the appreciation of the real exchange rate, induced by the appreciation of aggregate demand that follows the increases in government spending. To test the robustness of our open economic model, we conduct the same analysis in a corresponding closed economy model. The result from our closed economy model confirms the result obtained in the other work. Our theoretical results are consistent with the results obtained in the empirical literature, which uses the vector autoregressive method and the structural vector autoregressive approach to measure the impact of government‐spending shock on the real gross domestic product and revealed that the government‐spending multiplier tends to be lower in open economy.     

Monetary policy and exchange rate dynamics in the Spanish economy

As the Spanish economy gets more integrated in international markets, the real exchange rate becomes a key determinant of the monetary transmission. In this paper we trace out the dynamic response of prices, output and the exchange rate following a monetary policy shock. We estimate a structural VAR model whose identification scheme is based on the long run properties common to a large class of models. The results suggest that a small model with efficient asset markets plus nominal inertia and long run monetary neutrality, captures the essential features of the monetary transmission mechanism in Spain. The interest rate shock is well identified and the exchange rate overshoots its long run value. There are no signs of liquidity puzzle nor of price puzzle or exchange rate puzzle either.     

Macroeconomic dynamics in Macedonia and Slovakia: Structural estimation and comparison

This paper estimates a structural macroeconomic model using data for Macedonia and Slovakia to characterize possible challenges Macedonia can face concerning macroeconomic stabilization during its transition process. A comparison of the estimated model parameters suggests that, in Slovakia, the output gap is less sensitive to real interest rate movements and prices experience greater inertia. The estimated monetary policy reaction functions show Macedonia and Slovakia as inflation targeters, with Macedonia as the more conservative one, despite its officially applied exchange rate targeting regime. The differences in the estimated parameters imply differing transmission mechanisms for Macedonia and Slovakia. Consequently, the variance of domestic variables in Slovakia is most influenced by monetary policy shocks, while there is no single dominating shock explaining the volatility of Macedonia's macroeconomic variables. The exchange rate shock, the monetary policy shock and the demand shock are jointly important in determining the volatility of Macedonia's variables. The model simulations indicate that Macedonia experiences lower output gap and inflation volatility than Slovakia. This comes, nevertheless, at the cost of higher interest rate and real exchange rate volatility in Macedonia, which could be an indication of more volatile financial markets with possible negative implications for financial stability.     

Monetary Policy and Exchange Rate Interactions in a Small Open Economy

The transmission mechanisms of monetary policy in a small open economy like Norway are analysed through structural VARs, with special emphasis on the interdependence between monetary policy and exchange rate movements. By imposing a long‐run neutrality restriction on the real exchange rate, thereby allowing the interest rate and the exchange rate to react simultaneously to news, I find considerable interdependence between monetary policy and the exchange rate. In particular, following a contractionary monetary policy shock, the real exchange rate immediately appreciates, after which it gradually depreciates back to the baseline. The results are found to be consistent with findings from an “event study”.     

“Do Fiscal Deficits Influence Current Accounts? A Case Study of India”

This paper examines the effects of fiscal deficits on the current account deficits in the Indian economy. In many developing countries, fiscal deficits are mostly financed through monetization, causing crowding out of private investment expenditures. However, fiscal deficits in India are mostly financed through official borrowings from various external sources, leading to higher interest payments and outgoings on the external account. Such a policy could eventually precipitate balance of payments crises despite favorable trade account and real exchange rate. Data over three decades for the Indian economy show that, in addition to the real exchange rate and the ratio of private investment to GDP, fiscal deficits significantly contribute to the current account deficits.     

Exchange rate policy under sovereign default risk

We examine monetary policy options for a small open economy where sovereign default might occur due to intertemporal insolvency. Under interest rate policy and floating exchange rates the equilibrium is indetermined. Under a fixed exchange rate the equilibrium is uniquely determined and independent of sovereign default.     

负利率政策的传导渠道和有效性研究*

美国“次贷危机”之后全球经济深陷长期停滞状态,欧元区与日本相继实施负利率政策。负利率打破了政策利率零下限的教条,对现有理论提出了挑战。本文分析了负利率政策可能的传导渠道和影响负利率政策有效性的因素,并对现有的政策效果进行评估。本文发现负利率政策较容易对市场利率和汇率等金融市场变量产生影响;但就实体经济复苏而言,负利率政策成败的关键在于是否能有效增加贷款需求和供给。