A Quantitative Microfounded Model for the Integrated Policy Framework

By Tobias Adrian, Christopher J. Erceg, Marcin Kolasa, Jesper Lindé, Pawel Zabczyk

December 17, 2021

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Tobias Adrian, Christopher J. Erceg, Marcin Kolasa, Jesper Lindé, and Pawel Zabczyk. A Quantitative Microfounded Model for the Integrated Policy Framework, (USA: International Monetary Fund, 2021) accessed October 6, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

We develop a microfounded New Keynesian model to analyze monetary policy and financial stability issues in open economies with financial fragilities and weakly anchored inflation expectations. We show that foreign exchange intervention (FXI) and capital flow management tools (CFMs) can improve monetary policy tradeoffs under some conditions, including by reducing the need for procyclical tightening in response to capital outflow pressures. Moreover, they can be used in a preemptive way to reduce the risk of a “sudden stop” through curbing a buildup in leverage. While these tools can materially improve welfare, mainly by dampening inefficient fluctuations in risk premia, our analysis also highlights potential limitations, including the possibility that their deployment may forestall needed adjustment in the external balance. Finally, our results also emphasize the power of FXIs to provide domestic stimulus in a liquidity trap.

Subject: Balance of payments, Currency markets, Exchange rate devaluation, Exchange rates, Financial markets, Foreign exchange, Inflation, Prices, Sudden stops

Keywords: Capital Controls, Capital flow management tool, Currency markets, DSGE Model, Exchange rate devaluation, Exchange rates, FX intervention, FX Intervention, Global, Inflation, Liquidity trap, Monetary Policy, Monetary policy tradeoff, Policy rule, Sudden stops, Sudden Stops

Publication Details

Pages:

61
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2021/292
Stock No:

WPIEA2021292
ISBN:

9781616356538
ISSN:

1018-5941

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