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Exchange rate misalignment, capital flows, and optimal monetary policy trade-offs

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dc.contributor.author Corsetti, Giancarlo
dc.contributor.author Dedola, Luca
dc.contributor.author Leduc, Sylvain
dc.date.accessioned 2018-04-26T09:57:51Z
dc.date.available 2018-04-26T09:57:51Z
dc.date.issued 2018-03
dc.identifier.uri http://hdl.handle.net/10230/34480
dc.description.abstract What determines the optimal monetary trade-off between internal objectives (inflation, and output gap) and external objectives (competitiveness and trade imbalances) when inefficient capital flows cause exchange rate misalignment and distort current account positions? We characterize this trade-off analytically, using the workhorse model of modern monetary theory in open economies under incomplete markets–where inefficient capital flows and exchange rate misalignments can arise independently of nominal distortions. We derive a quadratic approximation of the utility-based global policy loss function under fairly general assumptions on preferences and openness, and solve for the optimal targeting rules under cooperation. We show that, in economies with a low degree of exchange rate pass-through, the optimal response to inefficient capital inflows associated with real appreciation is contractionary, above and beyond the natural rate: the optimal policy curbs excessive demand at the cost of exacerbating currency overvaluation. In contrast, a high degree of pass-through, and/or low trade elasticities, warrants expansionary policies that lean against exchange rate appreciation and competitive losses, at the cost of inefficient inflation.
dc.description.sponsorship The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.
dc.format.mimetype application/pdf
dc.language.iso eng
dc.relation.ispartofseries ADEMU Working Paper Series;89
dc.rights This is an Open Access article distributed under the terms of the Creative Commons Attribution License Creative Commons Attribution 4.0 International, which permits unrestricted use, distribution and reproduction in any medium provided that the original work is properlyattributed.
dc.rights.uri https://creativecommons.org/licenses/by/4.0/
dc.title Exchange rate misalignment, capital flows, and optimal monetary policy trade-offs
dc.type info:eu-repo/semantics/workingPaper
dc.subject.keyword Currency misalignments
dc.subject.keyword Trade imbalances
dc.subject.keyword Asset markets and risk sharing
dc.subject.keyword Optimal targeting rules
dc.subject.keyword International policy cooperation
dc.subject.keyword Exchange rate pass-through
dc.relation.projectID info:eu-repo/grantAgreement/EC/H2020/649396
dc.rights.accessRights info:eu-repo/semantics/openAccess

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