Type: Working Paper
Exchange rate misalignment and external imbalances : what is the optimal monetary policy response?
Working Paper, EUI RSC, 2022/71, Pierre Werner Chair Programme on Monetary Union
CORSETTI, Giancarlo, DEDOLA, Luca, LEDUC, Sylvain, Exchange rate misalignment and external imbalances : what is the optimal monetary policy response?, EUI RSC, 2022/71, Pierre Werner Chair Programme on Monetary Union - https://hdl.handle.net/1814/75061
Retrieved from Cadmus, EUI Research Repository
How should monetary policy respond to excessive capital inflows that appreciate the currency, widen the external de…cit and cause overheating? Using the workhorse open-macro model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, and solve for the optimal targeting rules under cooperation. The optimal monetary stance is expansionary if the exchange rate pass-through (ERPT) on import prices is complete, contractionary if nominal rigidities reduce the ERPT. Excessive capital inflows, however, may lead to currency undervaluation instead of overvaluation for some parameter values. The optimal stance is then invariably expansionary to support domestic demand.
Cadmus permanent link: https://hdl.handle.net/1814/75061
Series/Number: EUI RSC; 2022/71; Pierre Werner Chair Programme on Monetary Union
Publisher: European University Institute
Keyword(s): Currency misalignments Trade imbalances Asset markets and risk sharing Optimal targeting rules International policy cooperation
Published version: https://hdl.handle.net/1814/75937