Exchange Rate Misalignment and External Imbalances: What is the Optimal Monetary Policy Response?

Giancarlo Corsetti, Luca Dedola () and Sylvain Leduc

No 2008, Discussion Papers from Centre for Macroeconomics (CFM)

Abstract: How should monetary policy respond to capital inflows that appreciate the currency, widen the current account deficit and cause domestic overheating? Using the workhorse open-macro monetary model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, solve for the optimal targeting rules under cooperation and characterize the constrained-optimal allocation. The answer is sharp: the optimal monetary stance is contractionary if the exchange rate pass-through (ERPT) on import prices is incomplete, expansionary if ERPT is complete – implying that misalignment and exchange rate volatility are higher in economies where incomplete pass through contains the effects of exchange rates on price competitiveness.

Keywords: Currency misalignments; Trade imbalances; Asset markets and risk sharing; Optimal targeting rules; International policy cooperation; Exchange rate pass-through (search for similar items in EconPapers)
JEL-codes: E44 E52 E61 F41 F42 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2020-01
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www.centreformacroeconomics.ac.uk/Discussio ... MDP2020-08-Paper.pdf (application/pdf)

Related works:
Working Paper: Exchange Rate Misalignment and External Imbalances: What is the Optimal Monetary Policy Response? (2022)
Working Paper: Exchange Rate Misalignment and External Imbalances: What is the Optimal Monetary Policy Response? (2020)
Working Paper: Exchange Rate Misalignment and External Imbalances: What is the Optimal Monetary Policy Response? (2020)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cfm:wpaper:2008

Access Statistics for this paper

More papers in Discussion Papers from Centre for Macroeconomics (CFM) Contact information at EDIRC.
Bibliographic data for series maintained by Helen Power ().