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This paper studies optimal monetary policy in a two-sector small open economy model under segmented asset markets and sticky prices. We solve the Ramsey problem under full commitment, and characterize the optimal monetary policy in a calibrated version of the model. The findings of the paper are threefold. First, the Ramsey solution mimics the allocations under flexible prices. Second, under the optimal policy the volatility of non-tradable inflation is close to zero. Third, stabilizing nontradable inflation is optimal regardless of the financial structure of the small open economy. Even for a moderate degree of price stickiness, implementing a monetary policy that mitigates asset market segmentation is highly distortionary. This last result suggests that policymakers should resort to other policy instruments in order to correct financial imperfections.
Finance: General --- Inflation --- Macroeconomics --- Financial Markets and the Macroeconomy --- Monetary Policy --- Open Economy Macroeconomics --- Price Level --- Deflation --- General Financial Markets: General (includes Measurement and Data) --- Macroeconomics: Consumption --- Saving --- Wealth --- Finance --- Sticky prices --- Securities markets --- Consumption --- Asset prices --- Prices --- Financial markets --- National accounts --- Capital market --- Economics --- Chile
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We study interactions between monetary and macroprudential policies in a model with nominal and financial frictions. The latter derive from a financial sector that provides credit and liquidity services that lead to a financial accelerator-cum-fire-sales amplification mechanism. In response to fluctuations in world interest rates, inflation targeting dominates standard Taylor rules, but leads to increased volatility in credit and asset prices. The use of a countercyclical macroprudential instrument in addition to the policy rate improves welfare and has important implications for the conduct of monetary policy. “Leaning against the wind” or augmenting a standard Taylor rule with an argument on credit growth may not be an effective policy response.
Monetary policy --- Econometric models. --- Banks and Banking --- Labor --- Money and Monetary Policy --- Economic Theory --- Financial Markets and the Macroeconomy --- Monetary Policy --- Policy Objectives --- Policy Designs and Consistency --- Policy Coordination --- Open Economy Macroeconomics --- Labor Demand --- Interest Rates: Determination, Term Structure, and Effects --- Financial Economics --- Monetary economics --- Labour --- income economics --- Banking --- Economic theory & philosophy --- Reserve requirements --- Self-employment --- Central bank policy rate --- Inflation targeting --- Financial frictions --- Economic theory --- Financial services --- Self-employed --- Interest rates --- Economic forecasting --- Turkey
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In this paper, we analyze how lack of credibility and transparency of monetary and fiscal policies undermines the effectiveness of macroeconomic policies to isolate the economy from commodity price fluctuations. We develop a general equilibrium model for a commodity-exporting economy where macro policies are conducted through rules. We show that the responses of output, aggregate demand, and inflation to an increase in commodity price are magnified when these rules are imperfectly credible and lack transparency. If policies are imperfectly credible, then transparency helps private agents to learn the systematic behavior of the authorities, reducing the effects of commodity prices shocks. Coherent with the model, we show cross-country evidence that monetary policy transparency and fiscal credibility reduce the incidence of export price volatility on output volatility. Also, our results indicate that having an explicit fiscal rule and an inflation targeting regime contribute to isolate the economy from terms of trade fluctuations.
Commodity control. --- International commodity control --- Commercial policy --- Cartels --- Producers' associations --- Inflation --- Macroeconomics --- Public Finance --- Monetary Policy --- Central Banks and Their Policies --- Policy Objectives --- Policy Designs and Consistency --- Policy Coordination --- Fiscal Policies and Behavior of Economic Agents: General --- Commodity Markets --- Fiscal Policy --- Price Level --- Deflation --- Macroeconomics: Consumption --- Saving --- Wealth --- Commodity price shocks --- Fiscal policy --- Commodity price fluctuations --- Consumption --- Prices --- National accounts --- Economics --- United States
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This paper studies the Swedish fiscal consolidation episode of the 1990s through the lens of a small open economy model with distortionary taxation and unemployment. We argue that the simultaneous reduction in the fiscal deficit and unemployment rate in this episode stems from two factors: (i) high growth rates of total factor productivity (TFP), experienced after the implementation of structural reforms; and (ii) a sustained wage restraint that occurred during the 1990s. The model simulations show that economic growth, accounted for mostly by TFP gains, improved the fiscal balance by 8 percentage points of GDP through an expansion of the tax base and fiscal revenues. Moreover, the combination of stable wages and higher TFP boosted net exports and led to a reduction in the unemployment rate. A counterfactual simulation assuming stagnant TFP shows that fiscal consolidation measures alone would have generated a double-digit unemployment rate without eliminating the fiscal deficit.
Labor --- Macroeconomics --- Production and Operations Management --- Fiscal Policy --- Unemployment: Models, Duration, Incidence, and Job Search --- Taxation and Subsidies: Incidence --- Macroeconomics: Production --- Production --- Cost --- Capital and Total Factor Productivity --- Capacity --- Labour --- income economics --- Fiscal consolidation --- Unemployment rate --- Productivity --- Total factor productivity --- Fiscal stance --- Fiscal policy --- Industrial productivity --- Unemployment --- Sweden
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We study the use of foreign exchange (FX) intervention as an additional policy instrument in an environment with learning, where agents infer the central bank policy rules from its policy actions. Under full information, a central bank focused on stabilizing output and inflation can achieve better outcomes by using FX intervention as an additional policy tool. Under policy uncertainty, where agents perceive that monetary policy may also have exchange rate stabilization goals, the use of FX intervention entails a trade-off, reducing output volatility while increasing inflation volatility. While having an additional policy tool is always beneficial, we find that the optimal magnitude of intervention is higher in monetary policy regimes with lower uncertainty. These results indicate that the benefits of using FX intervention as an additional stabilization tool are greater in regimes where monetary policy is credibly focused on output and inflation stabilization.
Banks and Banking --- Exports and Imports --- Foreign Exchange --- Inflation --- Central Banks and Their Policies --- Open Economy Macroeconomics --- Price Level --- Deflation --- Banks --- Depository Institutions --- Micro Finance Institutions --- Mortgages --- International Investment --- Long-term Capital Movements --- Currency --- Foreign exchange --- Macroeconomics --- Banking --- International economics --- Exchange rates --- Capital inflows --- Prices --- Banks and banking --- Capital movements
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This paper evaluates how successful is a policy of exchange rate stabilization to counteract the negative effects of a Dutch Disease episode. We consider a small open economy model that incorporates nominal rigidities and a learning-by-doing externality in the tradable sector. The paper shows that leaning against an appreciated exchange rate can prevent an inefficient loss of tradable output but at the cost of generating a misallocation of resources in other sectors of the economy. The paper also finds that welfare is a decreasing function of exchange rate intervention. These results suggest that stabilizing the nominal exchange rate in response to a Dutch Disease episode is highly distortionary.
Foreign exchange rates --- Monetary policy --- International finance --- Econometric models. --- International monetary system --- International money --- Finance --- International economic relations --- Foreign Exchange --- Macroeconomics --- Economic Theory --- Resource Booms --- Macroeconomics: Consumption --- Saving --- Wealth --- Commodity Markets --- Currency --- Foreign exchange --- Economic theory & philosophy --- Exchange rates --- Real exchange rates --- Dutch disease --- Consumption --- Commodity prices --- Economic forecasting --- Economics --- Prices --- Canada
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