Advanced Search
MyIDEAS: Login to save this paper or follow this series

Should Monetary Policy React to Current Account Imbalances?

Contents:

Author Info

  • Sylvain Leduc

    (Federal Reserve Bank of San Francisco)

  • Luca Dedola

    (ECB and CEPR)

  • Giancarlo Corsetti

    (European University Institute and CEPR)

Abstract

Should monetary policy be preoccupied with large current account imbalances and extremely volatile exchange rates? Using a standard open economy model of pricing-to-market with incomplete asset markets and nominal rigidities, we show that the answer is yes. In our framework, supply shocks trigger important movements in demand via changes in wealth, which lead to large changes in current accounts and currency values, in line with the data. These substantial wealth effects also work to bring about significant departures from complete risk sharing and thus, combined with nominal rigidities, create a second distortion that pushes the economy away from the first-best allocation. We show that under cooperation, the optimal monetary policy largely corrects the distortions due to incomplete risk sharing, by reducing the shocks' wealth effects, and thus the movements in current account balances and exchange rates. In addition, we show that a simple Taylor rule that also responds to movements in the exchange rate comes close to replicating the optimal policy. Overall, our model suggests that a large current account deficit combined with an appreciating currency is a sign of excessive demand (relative to first best) and that monetary policy should be more restrictive as a result.

Download Info

To our knowledge, this item is not available for download. To find whether it is available, there are three options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.

Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 1219.

as in new window
Length:
Date of creation: 2009
Date of revision:
Handle: RePEc:red:sed009:1219

Contact details of provider:
Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Fax: 1-314-444-8731
Email:
Web page: http://www.EconomicDynamics.org/society.htm
More information through EDIRC

Related research

Keywords:

References

No references listed on IDEAS
You can help add them by filling out this form.

Citations

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:red:sed009:1219. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.