Working Paper: CEPR ID: DP6147
Authors: Michael B. Devereux; Alan Sutherland
Abstract: The process of financial globalization has significantly altered the environment in which national monetary policy authorities operate. What implications does this have for the design of monetary policy? The question can be properly addressed only in the context of a model where monetary policy interacts with financial market efficiency. This paper is concerned with the effects of monetary policy when international portfolio choice is endogenous. We analyze the link between monetary policy and gross national bond and equity portfolios. With endogenous portfolio structure and incomplete markets, monetary policy takes on new importance due to its impact on the distribution of returns on nominal assets. Despite this, we find that the case for price stability as an optimal monetary rule still remains. In fact, it is reinforced. Even without nominal price rigidities, price stability has a welfare benefit through its enhancement of the risk sharing properties of nominal bond returns.
Keywords: International risk sharing; Portfolio choice
JEL Codes: E52; E58; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial globalization (F30) | effectiveness of monetary policy (E52) |
| monetary policy (E52) | distribution of returns on nominal assets (G12) |
| distribution of returns on nominal assets (G12) | risk-sharing properties (D16) |
| price stability (E31) | welfare benefits through improved risk-sharing of nominal bond returns (H55) |
| price stability (E31) | international risk-sharing properties of nominal assets (G15) |
| monetary policy (E52) | composition of countries' portfolios (G15) |
| composition of countries' portfolios (G15) | effectiveness of nominal bonds as hedging instruments (G12) |