Managing Monetary Tradeoffs in Vulnerable Open Economies

Tobias Adrian, Christopher Erceg, Marcin Kolasa, Lindé, Jesper and Pawel Zabczyk
Authors registered in the RePEc Author Service: Jesper Lindé

No 16972, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We develop a microfounded New Keynesian model to analyze monetary policy and financial stability issues in open economies with financial fragilities and weakly anchored inflation expectations. We show that foreign exchange intervention (FXI) and capital flow management tools (CFMs) can improve monetary policy tradeoffs under some conditions, including by reducing the need for procyclical tightening in response to capital outflow pressures. Moreover, they can be used in a preemptive way to reduce the risk of a "sudden stop" through curbing a buildup in leverage. While these tools can materially improve welfare, mainly by dampening inefficient fluctuations in risk premia, our analysis also highlights potential limitations, including the possibility that their deployment may forestall needed adjustment in the external balance.

Keywords: Monetary policy; Fx intervention; Capital controls; Sudden stops; Dsge model (search for similar items in EconPapers)
JEL-codes: C54 E52 E58 F41 (search for similar items in EconPapers)
Date: 2022-01
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