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Should monetary policy lean against the wind in a small-open economy? Revisiting the Tinbergen rule

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  • De la Peña Rogelio

Abstract

It has been debated whether monetary policy should lean against the wind, i.e., if central banks should also respond to the build-up of financial imbalances. I contribute to the debate by showing that targeting the two policy objectives with a single instrument is more costly for a small-open economy than for a closed one. To this end, I develop a small-open economy DSGE model with the Bernanke-Gertler-Gilchrist financial accelerator that features financial frictions and monopolistic competition in goods markets. I then estimate this model for Mexico to explore the policy regimes yielding the lowest welfare cost. My main finding is that the Tinbergen rule is alive and well. In addition, my model is useful to gauge macroprudential measures effectiveness when discriminating against foreign liabilities.

Suggested Citation

  • De la Peña Rogelio, 2021. "Should monetary policy lean against the wind in a small-open economy? Revisiting the Tinbergen rule," Working Papers 2021-01, Banco de México.
    • Handle: RePEc:bdm:wpaper:2021-01
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    Keywords

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    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • 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
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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