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Limits of Monetary Policy Autonomy and Exchange Rate Flexibility by East Asian Central Banks

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  • Axel Löffler
  • Gunther Schnabl

    ()
    (Institute for Economic Policy, University of Leipzig)

  • Franziska Schobert

Abstract

Given low interest rates in the large industrial countries and buoyant capital inflows into the emerging markets East Asian central banks have accumulated large stocks of foreign reserves. As the resulting easing of monetary conditions has become a threat to domestic price and financial stability, the East Asian central banks have embarked on substantial sterilization operations to absorb what we call 'surplus liquidity' from the domestic banking systems. This has brought the East Asian central banks into debtor positions versus the domestic banking systems. We show based on a central bank loss function that given buoyant capital inflows and exchange rate stabilization the absorption of surplus liquidity leads either to financial repression, or rising inflation or both. Assuming that a debtor central bank moved towards a freely floating exchange rate to gain monetary policy independence, we show that monetary policy independence is undermined by sterilization costs and revaluation losses on foreign reserves.

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Bibliographic Info

Paper provided by Friedrich-Schiller-University Jena in its series Global Financial Markets Working Paper Series with number 48-2013.

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Date of creation: 22 Aug 2013
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Handle: RePEc:hlj:hljwrp:48-2013

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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. Ronald McKinnon & Gunther Schnabl, 2004. "The Return to Soft Dollar Pegging in East Asia. Mitigating Conflicted Virtue," International Finance, EconWPA 0406007, EconWPA, revised 07 Jul 2004.
  2. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, Elsevier, vol. 17(1-2), pages 1-13, August.
  3. Ronald Ian McKinnon & Gunther Schnabl, 2011. "China and its Dollar Exchange Rate: A Worldwide Stabilizing Influence?," CESifo Working Paper Series, CESifo Group Munich 3449, CESifo Group Munich.
  4. Schnabl, Gunther & Hoffmann, Andreas, 2007. "Monetary Policy, Vagabonding Liquidity and Bursting Bubbles in New and Emerging Markets - An Overinvestment View," MPRA Paper 5201, University Library of Munich, Germany.
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  7. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  8. Rishi Goyal & Ronald McKinnon, 2003. "Japan's Negative Risk Premium in Interest Rates: The Liquidity Trap and the Fall in Bank Lending," The World Economy, Wiley Blackwell, Wiley Blackwell, vol. 26(3), pages 339-363, 03.
  9. William R. Cline & John Williamson, 2010. "Estimates of Fundamental Equilibrium Exchange Rates, May 2010," Policy Briefs, Peterson Institute for International Economics PB10-15, Peterson Institute for International Economics.
  10. Broto, Carmen & Díaz-Cassou, Javier & Erce, Aitor, 2011. "Measuring and explaining the volatility of capital flows to emerging countries," Journal of Banking & Finance, Elsevier, Elsevier, vol. 35(8), pages 1941-1953, August.
  11. 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, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 17(1), pages 1-32.
  12. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  13. 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.
  14. Jonathan David Ostry & Atish R. Ghosh & Karl Friedrich Habermeier & Marcos Chamon & Mahvash Saeed Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows," IMF Staff Position Notes, International Monetary Fund 2010/04, International Monetary Fund.
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Cited by:
  1. Schnabl, Gunther, 2013. "The global move into the zero interest rate and high debt trap," Working Papers, University of Leipzig, Faculty of Economics and Management Science 121, University of Leipzig, Faculty of Economics and Management Science.

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