Kiel Working Papers, Kiel Institute for World Economics
No 1639:
Financial Globalization, Financial Frictions and Optimal Monetary Policy
Ester Faia and Eleni Iliopulos
Abstract: How should monetary policy be optimally designed in an
environment with high degrees of financial globalization? To answer this
question we lay down an open economy model where net lending toward the
rest of the world is constrained by a collateral constraint motivated by
limited enforcement. Borrowing is secured by collateral in the form of
durable goods whose accumulation is subject to adjustment costs. We
demonstrate that, although this economy can generate persistent current
account deficits, it can also deliver a stationary equilibrium. The
comparison between different monetary policy regimes (floating versus
pegged) shows that the impossible trinity is reversed: a higher degree of
financial globalization, by inducing more persistent and volatile current
account deficits, calls for exchange rate stabilization. Finally, we study
the design of optimal (Ramsey) monetary policy. In this environment the
policy maker faces the additional goal of stabilizing exchange rate
movements, which exacerbate fluctuations in the wedges induced by the
collateral constraint. In this context optimality requires deviations from
price stability and calls for exchange rate stabilization
Keywords: global imbalances, collateral constraints, monetary regimes; (follow links to similar papers)
JEL-Codes: E52,; F1; (follow links to similar papers)
45 pages, July 2010
Before downloading any of the electronic versions below
you should read our statement on
copyright.
Download GhostScript
for viewing Postscript files and the
Acrobat Reader for viewing and printing pdf files.
Downloadable files:
kwp-1639.pdf 
Download Statistics
Report other problems with accessing this service to Sune Karlsson ()
or Helena Lundin ().
Programing by
Design Joakim Ekebom
