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Monetary Policy Independence and the Strength of the Global Financial Cycle

Christian Friedrich, Pierre Guérin and Leiva-León, Danilo
Authors registered in the RePEc Author Service: Danilo Leiva-Leon

No 16203, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We propose a new strength measure of the global financial cycle by estimating a regime-switching factor model on cross-border equity flows. We then assess how this measure affects monetary policy independence, defined as central banks' responses to exogenous changes in inflation. We show that central banks tighten their policy rates in response to an unanticipated increase in inflation during times when global financial cycle strength is low, but their responses are muted when financial cycle strength is high. Finally, we show that capital controls, macroprudential policies, and a flexible exchange rate regime can increase monetary policy independence.

Keywords: Global financial cycle strength; Monetary policy independence; Capital controls; Macroprudential policies (search for similar items in EconPapers)
JEL-codes: E4 E5 F32 F42 G15 G18 (search for similar items in EconPapers)
Date: 2021-05
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