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Limits of Monetary Policy Autonomy by East Asian Debtor Central Banks

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  • Axel Löffler
  • Gunther Schnabl
  • Franziska Schobert

Abstract

Due to buoyant capital inflows East Asian central banks with exchange rate targets accumulate foreign reserves and thereby increase surplus liquidity. East Asian central banks with more flexible exchange rate regimes also face surplus liquidity that mainly emanates from past accumulation of foreign reserves. We show based on an augmented Barro-Gordon-type central bank loss function that in both cases surplus liquidity limits monetary policy autonomy. In case of fixed exchange rates East Asian central banks can escape from the impossible trinity and gain monetary policy autonomy by using non-market–based sterilization which leads to financial sector distortions. In a flexible exchange rate regime monetary policy autonomy can be gained without financial sector distortions by using market-based sterilization. As central banks face substantial sterilization costs as well as revaluation losses on foreign reserves, however, monetary policy autonomy is eroded.

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3742.

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Date of creation: 2012
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Handle: RePEc:ces:ceswps:_3742

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Keywords: debtor central banks; monetary policy autonomy; sterilization; exchange rate regime; East Asia;

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References

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  1. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(3), pages 473-91, June.
  2. Reinhart, Carmen & Reinhart, Vincent, 1999. "On the use of reserve requirements in dealing with capital flow problems," MPRA Paper 13703, University Library of Munich, Germany.
  3. Ronald McKinnon & Gunther Schnabl, 2009. "The Case for Stabilizing China's Exchange Rate: Setting the Stage for Fiscal Expansion," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 17(1), pages 1-32.
  4. Hans Genberg & Alexander Swoboda, 1993. "The Provision of Liquidity in the Bretton Woods System," NBER Chapters, in: A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform, pages 269-316 National Bureau of Economic Research, Inc.
  5. Andreas Hoffmann & Gunther Schnabl, 2007. "Monetary Policy, Vagabonding Liquidity and Bursting Bubbles in New and Emerging Markets – An Overinvestment View," CESifo Working Paper Series 2100, CESifo Group Munich.
  6. Lippman, Steven A & McCall, John J, 1986. "An Operational Measure of Liquidity," American Economic Review, American Economic Association, American Economic Association, vol. 76(1), pages 43-55, March.
  7. Robert J. Barro & David B. Gordon, 1983. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  8. Axel Löffler & Gunther Schnabl & Franziska Schobert, 2010. "Inflation Targeting by Debtor Central Banks in Emerging Market Economies," CESifo Working Paper Series 3138, CESifo Group Munich.
  9. Ronald Ian McKinnon & Gunther Schnabl, 2011. "China and its Dollar Exchange Rate: A Worldwide Stabilizing Influence?," CESifo Working Paper Series 3449, CESifo Group Munich.
  10. Ronald McKinnon & Gunther Schnabl, 2003. "The East Asian Dollar Standard, Fear of Floating, and Original Sin," Working Papers, Stanford University, Department of Economics 03001, Stanford University, Department of Economics.
  11. Gunther Schnabl & Franziska Schobert, 2009. "Global Asymmetries In Monetary Policy Operations: Debtor Central Banks Of The Mena Region," Manchester School, University of Manchester, vol. 77(s1), pages 85-107, 09.
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Cited by:
  1. McKinnon, Ronald, 2012. "Carry trades, interest differentials, and international monetary reform," Journal of Policy Modeling, Elsevier, Elsevier, vol. 34(4), pages 549-567.

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