Working Paper: CEPR ID: DP11070
Authors: Xuehui Han; Shangjin Wei
Abstract: This paper re-examines international transmissions of monetary policy shocks from advanced economies to emerging market economies. It combines three novel features. First, it separates co-movement in monetary policies due to common shocks from spillovers of monetary policies from advanced to peripheral economies. Second, it uses surprises in growth and inflation and the Taylor rule to gauge desired changes in a country?s interest rate if it focuses only on growth and inflation goals. Third, it proposes a specification that can work with the quantitative easing episodes when no changes in US interest rate are observed. We find that a flexible exchange rate regime per se does not deliver monetary policy autonomy (in contrast to the conclusions of Obstfeld (2015) and several others). Instead, some form of capital control appears necessary. Interestingly, a combination of capital controls and a flexible exchange rate may provide the most buffer for developing countries against foreign monetary policy shocks.
Keywords: capital control; exchange rate regime; monetary policy independence; Taylor rule; trilemma
JEL Codes: E42; E43; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| U.S. monetary policy (E52) | domestic interest rates in countries with flexible exchange rates (F31) |
| capital controls (F38) | monetary policy independence (E58) |
| capital controls + flexible exchange rate (F31) | buffer against foreign monetary policy shocks (F31) |
| flexible exchange rate alone (F31) | lack of monetary policy autonomy (E58) |
| flexible exchange rate + capital controls (F32) | insulation from U.S. monetary policy shocks (E39) |