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External debt and monetary policy autonomy

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  • Jonathan Scott Davis

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Abstract

During a time of rising world interest rates, the central bank of a small open economy may be motivated to increase its own interest rate to keep from suffering a destabilizing outflow of capital and depreciation in the exchange rate. Empirically, this paper shows that this is especially true for a small open economy with a current account deficit, which relies on foreign capital inflows to finance this deficit. In addition, the method of current account financing has a large effect on whether or not the central bank will opt for exchange rate and capital flow stabilization during a time of rising world interest rates. A current account deficit financed mainly through reserve depletion or the accumulation of private sector debt will cause the central bank to pursue de facto exchange rate stabilization, whereas a current account deficit financed through equity or FDI will not. Quantitatively, reserve depletion of about 7% of GDP will motivate the central bank with a floating currency to adjust its interest rate in line with the foreign interest rate to where it appears that the central bank has an exchange rate peg. ****** Durante un periodo de tasas de interés mundiales al alza, el banco central de una economía abierta pequeña podría verse motivado a aumentar su tasa de interés para evitar sufrir una salida de capital desestabilizadora y una depreciación de la tasa de cambio. El presente artículo muestra de manera empírica que esto es especialmente cierto para una economía abierta pequeña con un déficit en cuenta corriente, la cual depende de la entrada de capital extranjero para financiar su déficit. Asimismo, el método de financiación de cuenta corriente tiene un efecto importante sobre si el banco central optará o no por la estabilización de la tasa del cambio y flujo de capital durante un periodo de alza de tasa de interés mundial. Un déficit de cuenta corriente financiado fundamentalmente con el agotamiento de la reserva o la acumulación de deuda procedente del sector privado ocasionará que el banco central busque de facto la estabilización de la tasa de cambio, mientras que un déficit de cuenta corriente que se financie mediante la venta de acciones o inversión extranjera directa no lo hará. Desde el punto de vista cuantitativo, un agotamiento de la reserva de un 7% del PIB motivará que el banco central con moneda flotante ajuste su tasa de interés en línea con la tasa de interés extranjera con la que parezca que el banco central tiene fijado un tipo de cambio.

Suggested Citation

  • Jonathan Scott Davis, 2017. "External debt and monetary policy autonomy," Revista ESPE - Ensayos Sobre Política Económica, Banco de la República - ESPE, vol. 35(82), pages 53-63, April.
  • Handle: RePEc:col:000107:015479
    DOI: 10.1016/j.espe.2016.11.004
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    File URL: https://doi.org/10.1016/j.espe.2016.11.004
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    Cited by:

    1. Scott Davis, J. & Zlate, Andrei, 2019. "Monetary policy divergence and net capital flows: Accounting for endogenous policy responses," Journal of International Money and Finance, Elsevier, vol. 94(C), pages 15-31.
    2. Scott Davis & Andrei Zlate, 2017. "Monetary Policy Divergence, Net Capital Flows, and Exchange Rates: Accounting for Endogenous Policy Responses," Globalization Institute Working Papers 328, Federal Reserve Bank of Dallas, revised 01 Oct 2017.

    More about this item

    Keywords

    Tipos de cambio fijos; Cuenta corriente; Reservas; Currency pegs; Current account; Central bank reserves;

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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