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The Theoretical Superiority of the Compensation view in Explaining Monetary Policy Autonomy

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  • Zico Dasgupta

Abstract

This paper compares three theoretical frameworks that attempt to explain the phenomenon of weak relationship between foreign and domestic interest rate under fixed or manage-float exchange rate regimes - the Mundell-Fleming (MF) model without sterilization and the Mundell-Fleming model with sterilization (MFS) and the Compensation view. It argues for the theoretical superiority of the Compensation view as it can explain monetary policy autonomy under less restrictive assumptions. The paper outlines the underlying models of these frameworks and highlights the centrality of commercial bank loans in the Compensation view. I discuss the trend in India’s interest rates which is consistent with the Compensation view.

Suggested Citation

  • Zico Dasgupta, 2023. "The Theoretical Superiority of the Compensation view in Explaining Monetary Policy Autonomy," Working Papers PKWP2315, Post Keynesian Economics Society (PKES).
    • Handle: RePEc:pke:wpaper:pkwp2315
    as

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    File URL: https://www.postkeynesian.net/downloads/working-papers/PKWP2315.pdf
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    References listed on IDEAS

    as
    1. Rey, Hélène, 2015. "Dilemma not Trilemma: The Global Financial Cycle and Monetary Policy Independence," CEPR Discussion Papers 10591, C.E.P.R. Discussion Papers.
    2. Thomas I. Palley, 2013. "Horizontalists, verticalists, and structuralists: the theory of endogenous money reassessed," Review of Keynesian Economics, Edward Elgar Publishing, vol. 1(4), pages 406—424-4, OCT.
    3. Maurice Obstfeld & Kenneth Rogoff, 1995. "The Mirage of Fixed Exchange Rates," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 73-96, Fall.
    4. Maurice Obstfeld, 2021. "Trilemmas and Tradeoffs: Living with Financial Globalization," World Scientific Book Chapters, in: Steven J Davis & Edward S Robinson & Bernard Yeung (ed.), THE ASIAN MONETARY POLICY FORUM Insights for Central Banking, chapter 2, pages 16-84, World Scientific Publishing Co. Pte. Ltd..
    5. McCallum, Bennett T., 1996. "International Monetary Economics," OUP Catalogue, Oxford University Press, number 9780195094947.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Monetary Policy; Endogenous money; Mundell-Fleming; Compensation view; Sterilization;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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