Central Bank Exit Strategies Domestic Transmission and International Spillovers

By Christopher J. Erceg, Marcin Kolasa, Jesper Lindé, Haroon Mumtaz, Pawel Zabczyk

March 29, 2024

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Christopher J. Erceg, Marcin Kolasa, Jesper Lindé, Haroon Mumtaz, and Pawel Zabczyk. Central Bank Exit Strategies Domestic Transmission and International Spillovers, (USA: International Monetary Fund, 2024) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

We study alternative approaches to the withdrawal of prolonged unconventional monetary stimulus (“exit strategies”) by central banks in large, advanced economies. We first show empirically that large-scale asset purchases affect the exchange rate and domestic and foreign term premiums more strongly than conventional short-term policy rate changes when normalizing by the effects on domestic GDP. We then build a two-country New Keynesian model that features segmented bond markets, cognitive discounting and strategic complementarities in price setting that is consistent with these findings. The model implies that quantitative easing (QE) is the only effective way to provide monetary stimulus when policy rates are persistently constrained by the effective lower bound, and that QE is likely to have larger domestic output effects than quantitative tightening (QT). We demonstrate that “exit strategies” by large advanced economies that rely heavily on QT can trigger sizeable inflation-output tradeoffs in foreign recipient economies through the exchange rate and term premium channels. We also show that these tradeoffs are likely to be stronger in emerging market economies, especially those with fixed exchange rates.

Subject: Bonds, Central bank policy rate, Exchange rate arrangements, Financial institutions, Financial services, Foreign exchange, Inflation, Monetary policy, Prices, Unconventional monetary policies

Keywords: Appendix E. term premium, Asset purchase, Bonds, Central bank exit strategies, Central bank policy rate, Exchange rate arrangements, Global, Inflation, Inflation surge scenario, International Spillovers, Monetary Policy, Open economy, Policy conduct, Quantitative Easing, Unconventional monetary policies

Publication Details

Pages:

55
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2024/073
Stock No:

WPIEA2024073
ISBN:

9798400270864
ISSN:

1018-5941

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