Unconventional Monetary Policies in Small Open Economies

IMF Working Papers, April 4, 2025

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The paper provides a comprehensive assessment of the macroeconomic and fiscal impact of unconventional monetary tools in small open economies.
A DSGE model is used to examine mechanisms and to conduct a case study of the Swedish Riksbank asset purchases and negative policy rates during 2015-2019.
Key qualitative conclusion: the exchange rate plays a critical role in amplifying the favourable impact of unconventional monetary policy and attenuating the effectiveness of conventional fiscal policy to jointly boost output and inflation.

Framework: DSGE model calibrated for small open economies to evaluate macroeconomic and fiscal effects of unconventional monetary tools.
Purpose: Identify transmission channels (with emphasis on the exchange rate) and compare unconventional monetary policy versus conventional fiscal policy in their joint effects on output and inflation.

Application: The model is used as a laboratory to simulate and assess the Swedish Riksbank asset purchases and negative policy rates implemented in 2015-2019.
Outcome: The Riksbank unconventional policy measures provided meaningful macroeconomic stimulus to economic activity and inflation.

Government debt effects:
- Unconventional monetary policy (Riksbank measures) reduced overall government debt by about 5 percent of GDP.
- A commensurate output boost achieved instead by conventional fiscal policy would have produced a fiscal cost resulting in a deterioration of the government debt position with nearly 8 percent of GDP.
Inflation and output:
- If conventional fiscal policy had been used to provide a commensurate output boost, inflation would have risen notably less than under the Riksbank unconventional policy measures.

For small open economies, unconventional monetary policies that affect the exchange rate can deliver stronger joint gains in output and inflation than equivalent conventional fiscal expansions.
Policymakers should account for exchange rate amplification when choosing between unconventional monetary tools and fiscal measures to stimulate demand.
Fiscal authorities should weigh the larger fiscal cost (nearly 8 percent of GDP deterioration in the case study) of using conventional fiscal policy to mimic the output effects of unconventional monetary measures.

Source: https://www.imf.org/en/publications/wp/issues/2025/04/04/unconventional-monetary-policies-in-small-open-economies-565820