A Quantitative Model for the Integrated Policy Framework

IMF Working Papers, July 7, 2020

Source details

Authors: Tobias Adrian, Christopher J. Erceg, Jesper Lindé, Pawel Zabczyk, Jianping Zhou
Published: July 7, 2020
Series: IMF Working Papers
DOI: https://doi.org/10.5089/9781513549668.001

Many central banks use multiple policy tools, including foreign exchange intervention (FXI) and capital flow management tools (CFMs), to mitigate effects of volatile capital flows.
The paper develops an empirically-oriented New Keynesian model to evaluate and quantify how using multiple policy tools can potentially improve monetary policy tradeoffs.
The model embeds nonlinear balance sheet channels and includes a range of empirically-relevant frictions.
FXI and CFMs may improve policy tradeoffs under certain conditions:
- economies with less well-anchored inflation expectations,
- economies with substantial foreign currency mismatch,
- economies that are more vulnerable to shocks likely to induce capital outflows and exchange rate pressures.

Framework: empirically-oriented New Keynesian model.
Key model features:
- nonlinear balance sheet channels,
- empirically-relevant frictions (unspecified in the overview but emphasized as included).

FXI and CFMs can improve monetary policy tradeoffs under the specific conditions listed above.
Targeted vulnerabilities identified as amplifiers of effectiveness:
- less well-anchored inflation expectations,
- substantial foreign currency mismatch,
- higher vulnerability to capital-outflow–inducing shocks and exchange rate pressures.

Consider using a combination of FXI and CFMs when:
- inflation expectations are not well anchored,
- balance sheets exhibit substantial foreign currency mismatch,
- the economy is prone to shocks that generate capital outflows and exchange rate pressures.
Integrated use of multiple instruments can potentially improve monetary policy tradeoffs relative to relying on a single tool.