Monetary policy in an equilibrium portfolio balance model, Issues 2007-2072
International Monetary Fund, 2007 - Business & Economics - 31 pages
Standard theory shows that sterilized foreign exchange interventions do not affect equilibrium prices and quantities, and that domestic and foreign currency denominated bonds are perfect substitutes. This paper shows that when fiscal policy is not sufficiently flexible in response to spending shocks, perfect substitutability breaks down and uncovered interest rate parity no longer holds. Government balance sheet operations can be used as an independent policy instrument to target interest rates. Sterilized foreign exchange interventions should be most effective in developing countries, where fiscal volatility is large and where the fraction of domestic currency denominated government liabilities is small.
What people are saying - Write a review
We haven't found any reviews in the usual places.
Other editions - View all
asset markets Asset Prices assumption balance sheet operations baseline economy Bellman equation budget constraint calibration conjecture currency denominated bonds currency denominated government currency risk depreciation/inflation developing countries domestic assets domestic bonds domestic currency denominated drift and diffusion E,tdBt effects on interest endogenous equilibrium portfolio balance exchange rate movements exchange rate volatility exogenous fiscal spending fiscal policy fiscal shocks fiscal spending shocks foreign exchange intervention Forex Intervention OMO geometric Brownian motion government budget government debt government's Hamilton-Jacobi-Bellman equation households induced exchange rate Initial Forex Intervention international bonds Ito's Law lump-sum taxes monetary policy money supply nominal exchange rate nominal interest rate nominal money Obstfeld OE,t open market operation paper portfolio share premia real return risk premium seigniorage share of domestic shock processes small open economy sterilized foreign exchange sterilized intervention stochastic processes target path uncovered interest parity value function variance-covariance matrix wealth