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Financial Stability in Open Economies

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Author Info
Ippei Fujiwara (Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: ippei.fujiwara @boj.or.jp))
Yuki Teranishi (Associate Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: yuuki.teranishi @boj.or.jp))

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Abstract

This paper investigates the implications for monetary policy of financial markets that are internationally integrated but have intrinsic frictions. When there is no other distortion than financial market imperfections in the form of staggered international loan contracts, financial stability, which here constitutes eliminating the inefficient fluctuations of loan premiums, is the optimal monetary policy in open economies, regardless of whether policy coordination is possible. Yet, the optimality of inward-looking monetary policy requires an extra condition, in addition to those included in previous studies on the optimal monetary policy in open economies. To make allocations between cooperative and noncooperative monetary policy coincide, the exchange rate risk must be perfectly covered by the banks. Otherwise, each central bank has an additional incentive to control the nominal exchange rate to favor firms in her own country by reducing the exchange rate risk.

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Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 09-E-09.

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Date of creation: Mar 2009
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Handle: RePEc:ime:imedps:09-e-09

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Related research
Keywords: optimal monetary policy; policy coordination; global banking; international staggered loan contracts;

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Find related papers by JEL classification:
E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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