Central Bank Exit Strategies: Domestic Transmission and International Spillovers

Christopher Erceg, Marcin Kolasa, Jesper Lindé, Haroon Mumtaz and Pawel Zabczyk
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Haroon Mumtaz: School of Economics & Finance, Queen Mary University London

No 978, Working Papers from Queen Mary University of London, School of Economics and Finance

Abstract: 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 onlyeffective 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.

Keywords: Monetary Policy; Quantitative Easing; International Spillovers (search for similar items in EconPapers)
JEL-codes: C54 E52 E58 F41 (search for similar items in EconPapers)
Date: 2024-04-01
New Economics Papers: this item is included in nep-ban, nep-dge, nep-mon and nep-opm
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Related works:
Working Paper: Central Bank Exit Strategies: Domestic Transmission and International Spillovers (2024)
Working Paper: Central Bank Exit Strategies Domestic Transmission and International Spillovers (2024)
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