Faculty of Economics and Business Administration Publications Database

Financial Openness, Financial Frictions and Optimal Monetary Policy

Iliopulos, Eleni
Volume: 35
Number: 11
Pages: 1976 - 1996
Month: November
ISSN-Print: 0165-1889
Link External Source: Online Version
Year: 2011
Keywords: Global Imbalances; Collateral Constraints; Monetary Regimes
Abstract: Increasing financial integration challenges the optimality of inward-looking strategies for optimal monetary policy. Those issues are analyzed in an open economy where foreign net lending, and the current account, are determined by a collateral constraint. Durables represent collateral. The current account features persistent imbalances, but can deliver a long run stationary equilibrium. The comparison between floating and managed exchange rate regimes shows that the impossible trinity is reversed: higher financial integration increases the persistence and volatility of the current account and calls for exchange rate stabilization. In this context, the Ramsey plan too prescribes stabilization of the exchange rate, alongside with domestic inflation.