Self-oriented monetary policy, global financial markets and excess volatility of international capital flows

Ryan Banerjee, Michael Devereux and Giovanni Lombardo

No 540, BIS Working Papers from Bank for International Settlements

Abstract: This paper explores the nature of macroeconomic spillovers from advanced economies to emerging market economies (EMEs) and the consequences for independent use of monetary policy in EMEs. We first empirically document the effects of US monetary policy shocks on a sample group of EMEs. A contractionary monetary shock leads a retrenchment in EME capital flows, a fall in EME GDP, and an exchange rate depreciation. We construct a theoretical model which can help to account for these findings. In the model, macroeconomic spillovers are exacerbated by financial frictions. We assess the extent to which domestic monetary policy can mitigate the negative spillovers from foreign shocks. Absent financial frictions, international spillovers are minor, and an inflation targeting rule represents an effective policy for the EME. With frictions in financial intermediation, however, spillovers are substantially magnified, and an inflation targeting rule has little advantage over an exchange rate peg. However, an optimal monetary policy markedly improves on the performance of naive inflation targeting or an exchange rate peg. Furthermore, optimal policies don't need to be coordinated across countries. Under the specific set of assumptions maintained in our model, a non-cooperative, self-oriented optimal policy gives results very similar to those of a global cooperative optimal policy.

Keywords: International spillovers; Local Projections; Capital flows; Financial intermediaries; Monetary policy (search for similar items in EconPapers)
Pages: 43 pages
Date: 2016-01
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ifn, nep-mac, nep-mon and nep-opm
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Citations: View citations in EconPapers (86)

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Related works:
Journal Article: Self-oriented monetary policy, global financial markets and excess volatility of international capital flows (2016)
Working Paper: Self-Oriented Monetary Policy, Global Financial Markets and Excess Volatility of International Capital Flows (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:bis:biswps:540

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