A Quantitative Microfounded Model for the Integrated Policy Framework
IMF Working Papers, December 17, 2021
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- A Quantitative Microfounded Model for the Integrated Policy Framework
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Bibliographic details
- Authors: Tobias Adrian, Christopher J. Erceg, Marcin Kolasa, Jesper Lindé, Pawel Zabczyk
- Published: December 17, 2021
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781616356538.001
Model and scope
- Develops a microfounded New Keynesian model for open economies with financial fragilities and weakly anchored inflation expectations.
- Analyzes interactions among monetary policy, foreign exchange intervention (FXI), and capital flow management tools (CFMs).
- Explores roles of FXI and CFMs in reducing financial stability risks such as “sudden stops” and in influencing monetary policy tradeoffs.
Main findings
- FXI and CFMs can improve monetary policy tradeoffs under some conditions.
- These tools can reduce the need for procyclical tightening in response to capital outflow pressures.
- FXI and CFMs can be used preemptively to curb a buildup in leverage and reduce the risk of a “sudden stop”.
- The tools materially improve welfare mainly by dampening inefficient fluctuations in risk premia.
- FXIs can provide domestic stimulus in a liquidity trap.
Policy implications and recommendations
- Consider deploying FXI and CFMs to complement monetary policy when facing capital flow volatility and weakly anchored inflation expectations.
- Use CFMs and FXI preemptively to limit leverage buildups that raise sudden stop risk.
- Recognize FXI’s potential as a stimulus tool in liquidity-trap episodes.
- Monitor for potential adverse side effects: deployment of FXI and CFMs may forestall needed adjustment in the external balance.
Limitations and caveats
- Improvements from FXI and CFMs depend on specific conditions (not universally guaranteed).
- Deployment may delay necessary external balance adjustments.
- Welfare gains are driven mainly through reductions in inefficient risk-premia fluctuations; other channels and distributional effects may be relevant but are not the stated focus.
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