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on International Finance |
| By: | Marcin Kolasa (Narodowy Bank Polski); Grzegorz Wesołowski (Narodowy Bank Polski) |
| Abstract: | This paper develops a two-country model with asset market segmentation to investigate the effects of quantitative easing implemented by the major central banks on a typical small open economy that follows independent monetary policy. The model is able to replicate the key empirical facts on emerging countries’ response to large scale asset purchases conducted abroad, including inflow of capital to local sovereign bond markets, an increase in international comovement of term premia, and change in the responsiveness of the exchange rate to interest rate differentials. According to our simulations, quantitative easing abroad boosts domestic demand in the small economy, but undermines its international competitiveness and depresses aggregate output, at least in the short run. This is in contrast to conventional monetary easing in the large economy, which has positive spillovers to output in other countries. We also find that limiting these spillovers might require policies that affect directly international capital flows, like imposing capital controls or mimicking quantitative easing abroad by purchasing local long-term bonds. |
| Keywords: | quantitative easing, international spillovers, bond market segmentation, term premia |
| JEL: | E44 E52 F41 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:nbp:nbpmis:309&r=all |
| By: | Georgiadis, Georgios (European Central Bank); Zhu, Feng (Bank of International Settlements) |
| Abstract: | We assess the empirical validity of the trilemma (or impossible trinity) in the 2000s for a large sample of advanced and emerging market economies. To do so, we estimate Taylor-rule type monetary policy reaction functions, relating the local policy rate to real-time forecasts of domestic fundamentals, global variables, as well as the base-country policy rate. In the regressions, we explore variations in the sensitivity of local to base-country policy rates across different degrees of exchange rate flexibility and capital controls. We find that the data are in general consistent with the predictions from the trilemma: Both exchange rate flexibility and capital controls reduce the sensitivity of local to base-country policy rates. However, we also find evidence that is consistent with the notion that the financial channel of exchange rates highlighted in recent work reduces the extent to which local policymakers decide to exploit the monetary autonomy in principle granted by flexible exchange rates in specific circumstances: The sensitivity of local to base-country policy rates for an economy with a flexible exchange rate is stronger when it exhibits negative foreign-currency exposures which stem from portfolio debt and bank liabilities on its external balance sheet and when base-country monetary policy is tightened. The intuition underlying this finding is that it may be optimal for local monetary policy to mimic the tightening of base-country monetary policy and thereby mute exchange rate variation because a depreciation of the local currency would raise the cost of servicing and rolling over foreign-currency debt and bank loans, possibly up to a point at which financial stability is put at risk. |
| Keywords: | Trilemma; financial globalization; monetary policy autonomy; spillovers |
| JEL: | C50 E52 F42 |
| Date: | 2019–05–05 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:363&r=all |