Global Financial Conditions and Monetary Policy Autonomy

IMF Working Papers, June 8, 2016

Source details

Title: Global Financial Conditions and Monetary Policy Autonomy
Authors: Carlos Caceres, Yan Carriere-Swallow, Bertrand Gruss
Date: June 8, 2016
Research question: Is the Mundell-Fleming trilemma alive and well? The paper examines international co-movement of asset prices alongside synchronized business cycles and implications for identifying financial spillovers and assessing monetary policy autonomy.
Core benchmark: Impose the null hypothesis that central banks respond only to the outlook for domestic inflation and output.

Common approaches used to estimate interest rate spillovers tend to understate the degree of monetary autonomy enjoyed by small open economies with flexible exchange rates.
After applying an empirical strategy that partials out spillovers associated with impaired monetary autonomy, the authors find more compelling evidence that flexible exchange rates deliver monetary autonomy than prior work has suggested.
International co-movement of asset prices occurs alongside synchronized business cycles, which complicates identification of financial spillovers and assessments of monetary policy autonomy.

Proposes an empirical strategy that partials out those spillovers that are associated with impaired monetary autonomy.
Uses a benchmark for interest rate comovement based on the null hypothesis that central banks react only to domestic inflation and output outlooks.

Evidence supports the prediction of the Mundell-Fleming trilemma that flexible exchange rates can deliver monetary autonomy, more strongly than suggested by prior literature.
Assessments of monetary policy autonomy and interest rate spillovers should account for synchronized business cycles and asset-price co-movement to avoid understating autonomy for small open economies with flexible exchange rates.

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