A Quantitative Microfounded Model for the Integrated Policy Framework
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Summary:
We develop a microfounded New Keynesian model to analyze monetary policy and financial stability issues in open economies with financial fragilities and weakly anchored inflation expectations. We show that foreign exchange intervention (FXI) and capital flow management tools (CFMs) can improve monetary policy tradeoffs under some conditions, including by reducing the need for procyclical tightening in response to capital outflow pressures. Moreover, they can be used in a preemptive way to reduce the risk of a “sudden stop” through curbing a buildup in leverage. While these tools can materially improve welfare, mainly by dampening inefficient fluctuations in risk premia, our analysis also highlights potential limitations, including the possibility that their deployment may forestall needed adjustment in the external balance. Finally, our results also emphasize the power of FXIs to provide domestic stimulus in a liquidity trap.
Series:
Working Paper No. 2021/292
Subject:
Balance of payments Currency markets Exchange rate devaluation Exchange rates Financial markets Foreign exchange Inflation Prices Sudden stops
Frequency:
regular
English
Publication Date:
December 17, 2021
ISBN/ISSN:
9781616356538/1018-5941
Stock No:
WPIEA2021292
Pages:
61
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