Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/278675 
Year of Publication: 
2023
Series/Report no.: 
ECB Working Paper No. 2843
Publisher: 
European Central Bank (ECB), Frankfurt a. M.
Abstract: 
How should monetary policy respond to excessive capital inflows that appreciate the currency and widen the external deficit? Using the workhorse two-country 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 attenuate 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.
Subjects: 
Currency misalignment
trade imbalances
asset markets and risk sharing
optimal targeting rules
international policy cooperation
exchange rate pass-through
JEL: 
E44
E52
E61
F41
F42
Persistent Identifier of the first edition: 
ISBN: 
978-92-899-6128-8
Document Type: 
Working Paper

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