Working Paper: CEPR ID: DP16972
Authors: Tobias Adrian; Christopher J. Erceg; Jesper Lind; Marcin Kolasa; Pawel Zabczyk
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
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 and CFM (F20) | improve monetary policy tradeoffs (E52) |
| FXI and CFM (F20) | reduce procyclical tightening (E61) |
| FXI and CFM (F20) | dampen inefficient fluctuations in risk premia (D52) |
| FXI and CFM (F20) | improve welfare (I30) |
| FXI and CFM (F20) | forestall necessary adjustments in external balance (F32) |