Exchange rate misalignment and external imbalances: What is the optimal monetary policy response?

How should monetary policy respond to excessive capital inflows that appreciate the currency and widen the external deficit? Using the workhorse open-macro model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, and solve for the optimal t...

Full description

Saved in:
Bibliographic Details
Published in:Journal of international economics 2023-09, Vol.144, p.103771, Article 103771
Main Authors: Corsetti, Giancarlo, Dedola, Luca, Leduc, Sylvain
Format: Article
Language:English
Subjects:
Asset markets and risk sharing
Currency misalignment
Exchange rate pass-through
International policy cooperation
Optimal targeting rules
Trade imbalances
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:How should monetary policy respond to excessive capital inflows that appreciate the currency and widen the external deficit? Using the workhorse open-macro model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, and solve for the optimal targeting rules under cooperation. The optimal monetary stance is expansionary if the exchange rate pass-through (ERPT) on import prices is complete, contractionary if nominal rigidities attenuate ERPT. Excessive capital inflows, however, may lead to currency undervaluation instead of overvaluation for some parameter values. The optimal stance is then invariably expansionary to support domestic demand.
ISSN:0022-1996
1873-0353
DOI:10.1016/j.jinteco.2023.103771