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International policy spillovers at the zero lower bound

  • Haberis, Alex


    (Bank of England)

  • Lipińska, Anna


    (Federal Reserve Board)

In this paper, we consider how monetary policy in a large, foreign economy affects optimal monetary policy in a small open economy (‘home’) in response to a large global demand shock that pushes both economies to the zero lower bound (ZLB) on nominal interest rates. We show that the inability of foreign monetary policy to stabilise the foreign economy at the ZLB creates a spillover that affects how well the home policymaker is able to stabilise its own economy. We show that more stimulatory foreign policy worsens the home policymaker’s trade-off between stabilising inflation and the output gap when home and foreign goods are close substitutes. This reflects the fact that looser foreign policy leads to a relatively more appreciated home real exchange rate, which induces large expenditure switching away from home goods when goods are highly substitutable – just at a time (at the ZLB) when home policy is trying to boost demand for home goods. When goods are not close substitutes the home policymaker’s ability to stabilise the economy benefits from more stimulatory foreign policy.

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Paper provided by Bank of England in its series Bank of England working papers with number 464.

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Length: 47 pages
Date of creation: 07 Oct 2012
Date of revision:
Handle: RePEc:boe:boeewp:0464
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  1. Coenen, Günter & Wieland, Volker, 2003. "The zero-interest-rate bound and the role of the exchange rate for monetary policy in Japan," Working Paper Series 0218, European Central Bank.
  2. Benigno, Pierpaolo & López-Salido, David, 2002. "Inflation persistence and optimal monetary policy in the euro area," Working Paper Series 0178, European Central Bank.
  3. Adam, Klaus & Billi, Roberto M., 2007. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 728-752, April.
  4. Adam, Klaus & Billi, Roberto M, 2003. "Optimal Monetary Policy Under Commitment with a Zero Bound on Nominal Interest Rates," CEPR Discussion Papers 4111, C.E.P.R. Discussion Papers.
  5. Bianca De Paoli, 2004. "Monetary Policy and Welfare in a Small Open Economy," CEP Discussion Papers dp0639, Centre for Economic Performance, LSE.
  6. Gianluca Benigno & Pierpaolo Benigno, 2004. "Designing Target Rules for International Monetary Policy Cooperation," CEP Discussion Papers dp0666, Centre for Economic Performance, LSE.
  7. Anna Lipińska & Morten Spange & Misa Tanaka, 2011. "International Spillover Effects and Monetary Policy Activism," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(8), pages 1735-1748, December.
  8. Ippei Fujiwara & Nao Sudo & Yuki Teranishi, 2010. "The Zero Lower Bound and Monetary Policy in a Global Economy: A Simple Analytical Investigation," International Journal of Central Banking, International Journal of Central Banking, vol. 6(1), pages 103-134, March.
  9. Bodenstein, Martin & Erceg, Christopher & Guerrieri, Luca, 2010. "The Effects of Foreign Shocks When Interest Rates Are at Zero," CEPR Discussion Papers 8006, C.E.P.R. Discussion Papers.
  10. Jung, Taehun & Teranishi, Yuki & Watanabe, Tsutomu, 2005. "Optimal Monetary Policy at the Zero-Interest-Rate Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 813-35, October.
  11. Benigno, Gianluca & Benigno, Pierpaolo, 2003. "Designing targeting rules for international monetary policy cooperation," Working Paper Series 0279, European Central Bank.
  12. Pierpaolo Benigno & Michael Woodford, 2005. "Inflation Stabilization And Welfare: The Case Of A Distorted Steady State," Journal of the European Economic Association, MIT Press, vol. 3(6), pages 1185-1236, December.
  13. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  14. Nakajima, Tomoyuki, 2008. "Liquidity trap and optimal monetary policy in open economies," Journal of the Japanese and International Economies, Elsevier, vol. 22(1), pages 1-33, March.
  15. Tomohiro Sugo & Yuki Teranishi, 2008. "The Zero Interest Rate Policy," IMES Discussion Paper Series 08-E-20, Institute for Monetary and Economic Studies, Bank of Japan.
  16. Anton Nakov, 2006. "Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate," Banco de Espa�a Working Papers 0637, Banco de Espa�a.
  17. repec:tpr:qjecon:v:116:y:2001:i:2:p:421-445 is not listed on IDEAS
  18. Coenen, Guenter & Wieland, Volker, 2003. "The Zero-Interest-Rate and the Role of the Exchange Rate for Monetary Policy in Japan," CFS Working Paper Series 2003/09, Center for Financial Studies (CFS).
  19. Giancarlo Corsetti & Paolo Pesenti, 2001. "Welfare and Macroeconomic Interdependence," The Quarterly Journal of Economics, Oxford University Press, vol. 116(2), pages 421-445.
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