Working Paper: NBER ID: w23074
Authors: Scar Jord; Moritz Schularick; Alan M. Taylor
Abstract: The trilemma of international finance explains why interest rates in countries that fix their exchange rates and allow unfettered cross-border capital flows are largely outside the monetary authority’s control. Using historical panel-data since 1870 and using the trilemma mechanism to construct an external instrument for exogenous monetary policy fluctuations, we show that monetary interventions have very different causal impacts, and hence implied inflation-output trade-offs, according to whether: (1) the economy is operating above or below potential; (2) inflation is low, thereby bringing nominal rates closer to the zero lower bound; and (3) there is a credit boom in mortgage markets. We use several adjustments to account for potential spillover effects including a novel control function approach. The results have important implications for monetary policy.
Keywords: monetary policy; quasi-random experiments; trilemma; credit markets
JEL Codes: E01; E30; E32; E44; E47; E51; F33; F42; F44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Base country interest rates (E43) | Peg economies' interest rates (E43) |
| Monetary interventions (E52) | Macroeconomic outcomes (E19) |
| Contractionary monetary policy (E52) | Reduced output (E23) |
| Low inflation environment (E31) | Less effective monetary policy (E49) |
| High credit growth (E51) | More attractive contractionary monetary policy (E52) |
| Interest rate hikes (E43) | Decline in real GDP (E20) |
| Interest rate hikes (E43) | Decline in consumption (D12) |
| State of the economy (boom vs slump) (E32) | Effectiveness of monetary policy (E52) |