Monetary Policy Spillovers under Intermediate Exchange Rate Regimes

Ahmed, Rashad (2020): Monetary Policy Spillovers under Intermediate Exchange Rate Regimes.

Abstract

I investigate monetary policy transmission under the Trilemma across Advanced and Emerging Market Economies, paying particular attention on the extent of spillovers under intermediate exchange rate regimes (i.e. managed floats). The extent of monetary pass-through: 1) is broadly significant, but more incomplete in Emerging Markets than Advanced Economies, 2) occurs over both the short-run and longer-run, 3) varies within intermediate exchange rate regimes, 4) appears to be diversifiable under a basket peg, and 5) is non-linear in exchange rate flexibility. The latter three points suggest that near-corner exchange rate policies can carry starkly different implications from corner policies themselves: Countries can face almost the same monetary autonomy as under a float without resorting to a pure float. Countries under a fixed regime appear to gain disproportionate monetary independence by giving up relatively little exchange rate stability. The use of international reserves as an additional policy instrument appears to play a role in explaining these non-linearities, particularly in Emerging Markets. Such gains in monetary autonomy are allocated towards domestic objectives differently across Advanced Economies and Emerging Markets. Advanced Economies tend to put greater emphasis on output stabilization while Emerging Markets focus on inflation. Non-linear policy trade-offs under intermediate exchange rate regimes may help explain the continuous rejection of the Two Corners hypothesis, the scarcity of true pure floats, and the persistent dominance of middle-ground exchange rate policy.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary policy, exchange rate regimes, international spillovers, policy trilemma
• Subjects: F - International Economics > F3 - International Finance; F - International Economics > F3 - International Finance > F31 - Foreign Exchange

References

[1] Rashad Ahmed, Joshua Aizenman, and Yothin Jinjarak. Inflation and exchange rate targeting challenges under fiscal dominance. Working Paper 25996, National Bureau of Economic Research, June 2019. [2] Joshua Aizenman, Menzie D. Chinn, and Hiro Ito. The emerging global financial architecture: Tracing and evaluating new patterns of the trilemma configuration. Journal of International Money and Finance, 29(4):615–641, June 2010. [3] Joshua Aizenman, Menzie D. Chinn, and Hiro Ito. Monetary policy spillovers and the trilemma in the new normal: Periphery country sensitivity to core country conditions. Journal of International Money and Finance, 68(C):298–330, 2016. [4] Joshua Aizenman, Menzie David Chinn, and Hiro Ito. The “Impossible Trinity” Hypothesis in an Era of Global Imbalances: Measurement and Testing. Review of International Economics, 21(3):447–458, August 2013. [5] Joshua Aizenman, Michael Hutchison, and Ilan Noy. Inflation Targeting and Real Exchange Rates in Emerging Markets. World Development, 39(5):712–724, May 2011. [6] Joshua Aizenman and Hiro Ito. The More Divergent, the Better? Lessons on Trilemma Policies and Crises for Asia. Asian Development Review, 31(2):21–54, September 2014. [7] Stefan Angrick. Global liquidity and monetary policy autonomy: an examination of open-economy policy constraints. Cambridge Journal of Economics, 42(1):117–135, January 2018. [8] Ravi Bansal and Magnus Dahlquist. The forward premium puzzle: different tales from developed and emerging economies. Journal of international Economics, 51(1):115–144, 2000.

[9] Agnes Benassy-Quere, Benoit Coeure, and Valerie Mignon. On the identification of de facto currency pegs. Journal of the Japanese and International Economies, 20(1):112–127, March 2006. [10] John C. Bluedorn and Christopher Bowdler. The Empirics of International Monetary Transmission: Identification and the Impossible Trinity. Journal of Money, Credit and Banking, 42(4):679–713, June 2010. [11] European Central Bank Executive Board. The International Role of the Euro, 2019. [12] Guillermo A. Calvo and Carmen M. Reinhart. Fear of Floating. The Quarterly Journal of Economics, 117(2):379–408, 2002. [13] Menzie D. Chinn and Hiro Ito. What matters for financial development? Capital controls, institutions, and interactions. Journal of Development Economics, 81(1):163–192, October 2006. [14] Michael B. Devereux and Charles Engel. Fixed vs. Floating Exchange Rates: How Price Setting Affects the Optimal Choice of Exchange-Rate Regime. NBER Working Papers 6867, National Bureau of Economic Research, Inc, December 1998. [15] Sebastian Edwards. The Determinants of the Choice between Fixed and Flexible Exchange-Rate Regimes. NBER Working Papers 5756, National Bureau of Economic Research, Inc, September 1996. [16] Barry Eichengreen. The Open-Economy Trilemma in the Long Run. Korean Economic Review, 34:5–28, 2018. [17] Charles Engel. The forward discount anomaly and the risk premium: A survey of recent evidence. Journal of Empirical Finance, 3(2):123–192, 1996. [18] Charles Engel. Currency misalignments and optimal monetary policy: A reexamination. American Economic Review, 101(6):2796–2822, October 2011. [19] Eugene F. Fama. Forward and spot exchange rates. Journal of Monetary Economics, 14(3):319–338, November 1984. [20] Stanley Fischer. Exchange Rate Regimes: Is the Bipolar View Correct? Journal of Economic Perspectives, 15(2):3–24, Spring 2001.

[21] Kristin J. Forbes and Roberto Rigobon. No contagion, only interdependence: Measuring stock market comovements. The Journal of Finance, 57(5):2223–2261, 2002. [22] Jeffrey Frankel. Systematic Managed Floating. Open Economies Review, 30(2):255–295, April 2019. [23] Jeffrey Frankel, Eduardo Fajnzylber, Sergio Schmukler, and Luis Serven. Verifying exchange rate regimes. Journal of Development Economics, 66(809):351–386, 2001. [24] Jeffrey Frankel, Xiaonan Ma, and Danxia Xie. The impact of exchange rate regimes on economic growth with continuous classification of de facto regimes. Working Paper. [25] Jeffrey Frankel, Sergio Schmukler, and Luis Serven. Verifiability and the vanishing intermediate exchange rate regime. Working Paper 7901, National Bureau of Economic Research, September 2000. [26] Jeffrey Frankel, Sergio L. Schmukler, and Luis Serven. Global transmission of interest rates: monetary independence and currency regime. Journal of International Money and Finance, 23(5):701–733, September 2004. [27] Jeffrey A. Frankel. Is Japan Creating a Yen Bloc in East Asia and the Pacific?, pages 53–88. The University of Chicago Press, January 1993. [28] Jeffrey A. Frankel and Shang-Jin Wei. Yen bloc or dollar bloc: exchange rate policies of the East Asian economies. Technical report, 1992. [29] Jeffrey A Frankel and Shang-Jin Wei. Emerging currency blocs. Working Paper 4335, National Bureau of Economic Research, April 1993. [30] Georgios Georgiadis and Feng Zhu. Monetary policy spillovers, capital controls and exchange rate flexibility, and the financial channel of exchange rates. BIS Working Papers 797, Bank for International Settlements, July 2019. [31] Linda S. Goldberg and Robert Lerman. The U.S. Dollar’s Global Roles: Where Do Things Stand?, 2019. [32] A G Haldane and S G Hall. Sterling’s Relationship with the Dollar and the Deutschemark: 1976-89. Economic Journal, 101(406):436–443, May 1991.

[33] Xuehui Han and Shang-Jin Wei. Policy Choices and Resilience to International Monetary Shocks. Global Economic Review, 43(4):319–337, December 2014. [34] Xuehui Han and Shang-Jin Wei. International transmissions of monetary shocks: Between a trilemma and a dilemma. Journal of International Economics, 110(C):205–219, 2018. [35] Bruce E. Hansen. Sample Splitting and Threshold Estimation. Econometrica, 68(3):575–604, May 2000. [36] Helmut Herwartz and Jan Roestel. Mundell’s trilemma: Policy tradeoffs within the middle ground. Journal of International Money and Finance, 75(C):1–13, 2017. [37] Ethan Ilzetzki, Carmen M Reinhart, and Kenneth S Rogoff. Exchange Arrangements Entering the Twenty-First Century: Which Anchor will Hold? The Quarterly Journal of Economics, 134(2):599–646, 2019. [38] Hiro Ito and Masahiro Kawai. New Measures of the Trilemma Hypothesis : Implications for Asia. Macroeconomics Working Papers 23331, East Asian Bureau of Economic Research, September 2012. [39] Hiro Ito and Masahiro Kawai. Determinants of the Trilemma Policy Combination. ADBI Working Papers 456, Asian Development Bank Institute, January 2014. [40] Hiro Ito and Masahiro Kawai. Trade invoicing in major currencies in the 1970s–1990s: Lessons for renminbi internationalization. Journal of the Japanese and International Economies, 42(C):123–145, 2016. [41] Hiro Ito and Robert N. McCauley. A key currency view of global imbalances. Journal of International Money and Finance, 94(C):97–115, 2019. [42] `Oscar Jorda`, Moritz Schularick, and Alan M. Taylor. Betting the house. Journal of International Economics, 96(S1):2–18, 2015. [43] Ruth A. Judson and Ann L. Owen. Estimating dynamic panel data models: a guide for macroeconomists. Economics Letters, 65(1):9–15, October 1999. [44] Sebnem Kalemli-Ozcan. U.s. monetary policy and international risk spillovers. Working Paper 26297, National Bureau of Economic Research, September 2019.

[45] Michael W. Klein and Jay C. Shambaugh. Rounding the Corners of the Policy Trilemma: Sources of Monetary Policy Autonomy. American Economic Journal: Macroeconomics, 7(4):33–66, October 2015. [46] Kenneth N. Kuttner. Monetary policy surprises and interest rates: Evidence from the Fed funds futures market. Journal of Monetary Economics, 47(3):523–544, June 2001. [47] Paul R Masson. Exchange rate regime transitions. Journal of Development Economics, 64(2):571 – 586, 2001. [48] Robert N McCauley and Tracy Chan. Currency movements drive reserve composition. BIS Quarterly Review, December 2014. [49] Jacques Miniane and John H. Rogers. Capital Controls and the International Transmission of U.S. Money Shocks. Journal of Money, Credit and Banking, 39(5):1003–1035, August 2007. [50] Silvia Miranda-Agrippino and H´el`ene Rey. U.S. Monetary Policy and the Global Financial Cycle. (21722), November 2015. [51] R. A. Mundell. Capital mobility and stabilization policy under fixed and flexible exchange rates. The Canadian Journal of Economics and Political Science / Revue canadienne d’Economique et de Science politique, 29(4):475–485, 1963. [52] Stephen J Nickell. Biases in Dynamic Models with Fixed Effects. Econometrica, 49(6):1417–1426, November 1981. [53] Maurice Obstfeld, Jonathan D. Ostry, and Mahvash S. Qureshi. A Tie That Binds: Revisiting the Trilemma in Emerging Market Economies. The Review of Economics and Statistics, 101(2):279–293, May 2019. [54] Maurice Obstfeld, Jay C. Shambaugh, and Alan M. Taylor. The Trilemma in History: Tradeoffs Among Exchange Rates, Monetary Policies, and Capital Mobility. The Review of Economics and Statistics, 87(3):423–438, August 2005. [55] Maurice Obstfeld, Jay C. Shambaugh, and Alan M. Taylor. Financial stability, the trilemma, and international reserves. American Economic Journal: Macroeconomics, 2(2):57–94, April 2010. [56] H´el`ene Rey. Dilemma not Trilemma: The Global Financial Cycle and Monetary Policy Independence. NBER Working Papers 21162, National Bureau of Economic Research, Inc, May 2015.

[57] Jay C. Shambaugh. The Effect of Fixed Exchange Rates on Monetary Policy. The Quarterly Journal of Economics, 119(1):301–352, 2004. [58] Andreas Steiner. Central banks and macroeconomic policy choices: Relaxing the trilemma. Journal of Banking Finance, 77:283 – 299, 2017. [59] Gang-Jin Wang, Chi Xie, Min Lin, and H. Eugene Stanley. Stock market contagion during the global financial crisis: A multiscale approach. Finance Research Letters, 22(C):163–168, 2017. [60] John Williamson. The evolution of thought on intermediate exchange rate regimes. The Annals of the American Academy of Political and Social Science, 579:73–86, 2002. [61] `Oscar Jorda`, Moritz Schularick, and Alan M. Taylor. The effects of quasi-random monetary experiments. Journal of Monetary Economics, 2019.