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Current Account Dynamics and Monetary Policy

In: International Dimensions of Monetary Policy

  • Andrea Ferrero
  • Mark Gertler
  • Lars E. O. Svensson

We explore the implications of current account adjustment for monetary policy within a simple two country SGE model. Our framework nests Obstfeld and Rogoff's (2005) static model of exchange rate responsiveness to current account reversals. It extends this approach by endogenizing the dynamic adjustment path and by incorporating production and nominal price rigidities in order to study the role of monetary policy. We consider two different adjustment scenarios. The first is a "slow burn" where the adjustment of the current account deficit of the home country is smooth and slow. The second is a "fast burn" where, owing to a sudden shift in expectations of relative growth rates, there is a rapid reversal of the home country's current account. We examine several different monetary policy regimes under each of these scenarios. Our principal finding is that the behavior of the domestic variables (for instance, output, inflation) is quite sensitive to the monetary regime, while the behavior of the international variables (for instance, the current account and the real exchange rate) is less so. Among different policy rules, domestic inflation targeting achieves the best stabilization outcome of aggregate variables. This result is robust to the presence of imperfect pass-through on import prices, although in this case stabilization of consumer price inflation performs similarly well.

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This chapter was published in:
  • Jordi Galí & Mark J. Gertler, 2010. "International Dimensions of Monetary Policy," NBER Books, National Bureau of Economic Research, Inc, number gert07-1, July.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 0521.
    Handle: RePEc:nbr:nberch:0521
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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    1. Maurice Obstfeld & Kenneth Rogoff, 2007. "The Unsustainable U.S. Current Account Position Revisited," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 339-376 National Bureau of Economic Research, Inc.
    2. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers 646, Stockholm University, Institute for International Economic Studies.
    3. Mark Gertler & Simon Gilchrist & Fabio Natalucci, 2001. "External constraints on monetary policy and the financial accelerator," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    4. Vasco Cúrdia, 2005. "Monetary Policy under Sudden Stops," International Finance 0510025, EconWPA, revised 02 Nov 2005.
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    8. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
    9. Benigno, Gianluca & Benigno, Pierpaolo, 2006. "Designing targeting rules for international monetary policy cooperation," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 473-506, April.
    10. Nir Jaimovich & Sergio Rebelo, 2006. "Can News About the Future Drive the Business Cycle?," 2006 Meeting Papers 31, Society for Economic Dynamics.
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    18. Martin Bodenstein, 2006. "Closing open economy models," International Finance Discussion Papers 867, Board of Governors of the Federal Reserve System (U.S.).
    19. Tommaso Monacelli, 2003. "Monetary Policy in a Low Pass-Through Environment," Working Papers 228, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    20. Jose Manuel Campa & Linda S. Goldberg, 2006. "Distribution margins, imported inputs, and the sensitivity of the CPI to exchange rates," Staff Reports 247, Federal Reserve Bank of New York.
    21. Hamid Faruqee & Douglas Laxton & Dirk Muir & Paolo Pesenti, 2005. "Smooth landing or crash? model based scenarios of global current account rebalancing," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
    22. Enrique G. Mendoza, 2007. "Financial Integration, Financial Deepness and Global Imbalance," 2007 Meeting Papers 746, Society for Economic Dynamics.
    23. Benigno, Pierpaolo, 2004. "Optimal monetary policy in a currency area," Journal of International Economics, Elsevier, vol. 63(2), pages 293-320, July.
    24. David Backus & Espen Henriksen & Frederic Lambert & Christopher Telmer, 2009. "Current Account Fact and Fiction," NBER Working Papers 15525, National Bureau of Economic Research, Inc.
    25. Andrea Ferrero, 2007. "The long-run determinants of U.S. external imbalances," Staff Reports 295, Federal Reserve Bank of New York.
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