Exchange rate misalignment and external imbalances: what is the optimal monetary policy response?
Giancarlo Corsetti,
Luca Dedola and
Sylvain Leduc
No 2843, Working Paper Series from European Central Bank
Abstract:
How should monetary policy respond to excessive capital in•ows that appreciate the currency and widen the external de•cit? Using the workhorse two-country 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 in•ows, however, may lead to currency undervaluation instead of overvaluation for some parameter values. The optimal stance is then invariably expansionary to support domestic demand. JEL Classification: E44, E52, E61, F41, F42
Keywords: asset markets and risk sharing; currency misalignment; exchange rate pass-through; international policy cooperation; optimal targeting rules; trade imbalances (search for similar items in EconPapers)
Date: 2023-08
New Economics Papers: this item is included in nep-dge, nep-ifn, nep-mon, nep-opm and nep-upt
Note: 80922
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Citations: View citations in EconPapers (4)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20232843
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