A Quantitative Microfounded Model for the Integrated Policy Framework

Author/Editor:

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

Publication Date:

December 17, 2021

Electronic Access:

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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.

Series:

Working Paper No. 2021/292

Frequency:

regular

English

Publication Date:

December 17, 2021

ISBN/ISSN:

9781616356538/1018-5941

Stock No:

WPIEA2021292

Pages:

61

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