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Country Portfolios, Collateral Constraints and Optimal Monetary Policy

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  • Sutherland, Alan
  • Senay, Ozge

Abstract

Recent literature shows that, when international financial trade is absent, optimal policy deviates significantly from strict inflation targeting, but when there is trade in equities and bonds, optimal policy is close to strict inflation targeting. A separate line of literature shows that collateral constraints can imply that cross-border portfolio holdings act as a shock transmission mechanism which significantly undermines risk sharing. This raises an important question: does asset trade in the presence of collateral constraints imply a greater role for monetary policy as a risk sharing device? This paper finds that the combination of asset trade with collateral constraints does imply a potentially large welfare gain from optimal policy (relative to inflation targeting). However, the welfare gain of optimal policy is even larger when there is no international asset trade (but collateral constraints bind within each country). In other words, the risk sharing role of asset trade tends to reduce the welfare gains from policy optimisation even when collateral constraints act as a shock transmission mechanism. This is true even when there are large and persistent collateral constraint shocks.

Suggested Citation

  • Sutherland, Alan & Senay, Ozge, 2016. "Country Portfolios, Collateral Constraints and Optimal Monetary Policy," CEPR Discussion Papers 11499, Centre for Economic Policy Research.
    • Handle: RePEc:cpr:ceprdp:11499
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    References listed on IDEAS

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    1. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2010. "Optimal Monetary Policy in Open Economies," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 16, pages 861-933, Elsevier.
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    5. Senay, Ozge & Sutherland, Alan, 2019. "Optimal monetary policy, exchange rate misalignments and incomplete financial markets," Journal of International Economics, Elsevier, vol. 117(C), pages 196-208.
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    Cited by:

    1. Senay, Ozge & Sutherland, Alan, 2019. "Optimal monetary policy, exchange rate misalignments and incomplete financial markets," Journal of International Economics, Elsevier, vol. 117(C), pages 196-208.
    2. Staveley-O’Carroll, James & Staveley-O’Carroll, Olena M., 2018. "Exchange rate targeting in the presence of foreign debt obligations," Journal of Macroeconomics, Elsevier, vol. 56(C), pages 113-134.

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    Keywords

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    JEL classification:

    • 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
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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