Working Paper: CEPR ID: DP15065
Authors: Tobias Adrian; Christopher J. Erceg; Jesper Lind; Pawel Zabczyk; Jianping Zhou
Abstract: Many central banks have relied on a range of policy tools, including foreign exchange intervention (FXI) and capital flow management tools (CFMs), to mitigate the effects of volatile capital flows on their economies. We develop an empirically-oriented New Keynesian model to evaluate and quantify how using multiple policy tools can potentially improve monetary policy tradeoffs. Our model embeds nonlinear balance sheet channels and includes a range of empirically-relevant frictions. We show that FXI and CFMs may improve policy tradeoffs under certain conditions, especially for economies with less well-anchored inflation expectations, substantial foreign currency mismatch, and that are more vulnerable to shocks likely to induce capital outflows and exchange rate pressures.
Keywords: Monetary Policy; FX Intervention; Capital Flow Measures; Emerging Economies; DSGE Model
JEL Codes: C54; E52; E58; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| FXI (F20) | stabilize exchange rate (F31) |
| FXI (F20) | mitigate inflationary pressures (E31) |
| FXI (F20) | tighter monetary policy (E52) |
| tighter monetary policy (E52) | contract output (D86) |
| UIP risk premium shock (F31) | exchange rate depreciation (F31) |
| exchange rate depreciation (F31) | expansionary output effect in AEs (F41) |
| exchange rate depreciation (F31) | significant trade-offs in EMEs (F14) |
| weak initial conditions (C62) | enhance effectiveness of FXI and CFMs (G15) |
| FXI and CFMs (F20) | reduce downside risks to GDP (E20) |
| FXI and CFMs (F20) | incur longer-term costs (J32) |