Optimal monetary policy, exchange rate misalignments and incomplete financial markets
Abstract
Recent literature shows that, when international financial trade is restricted to autarky or a single bond, there are internal and external welfare trade-offs that imply optimal monetary policy, in principle, deviates from inflation targeting in order to offset real exchange rate misalignments. This paper develops a more realistic model of incomplete markets, where there is international trade in multiple assets. The analysis shows that the presence of multiple assets creates a potentially powerful interaction between monetary policy and household portfolio allocation. This interaction is, by definition, not present when there is financial autarky or a single tradeable bond and this paper shows that the interaction with portfolio allocation can imply that optimal monetary policy generates a quantitatively much more significant stabilisation of the real exchange rate gap than implied by simpler models of financial market incompleteness.
Citation
Senay , O & Sutherland , A J 2019 , ' Optimal monetary policy, exchange rate misalignments and incomplete financial markets ' , Journal of International Economics , vol. 117 , pp. 196-208 . https://doi.org/10.1016/j.jinteco.2018.12.001
Publication
Journal of International Economics
Status
Peer reviewed
ISSN
0022-1996Type
Journal article
Rights
Copyright © 2018, Elsevier B.V. This work is made available online in accordance with the publisher’s policies. This is the author created, accepted version manuscript following peer review and may differ slightly from the final published version. The final published version of this work is available at https://doi.org/10.1016/j.jinteco.2018.12.001
Description
This research is supported by ESRC Award Number ES/I024174/1.Collections
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