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Monetary Policy Independence and the Strength of the Global Financial Cycle

Author

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  • Friedrich, Christian
  • Guerin, Pierre
  • Leiva-León, Danilo

Abstract

We propose a new strength measure of the global financial cycle by estimating a regime-switching factor model on cross-border equity flows. We then assess how this measure affects monetary policy independence, defined as central banks' responses to exogenous changes in inflation. We show that central banks tighten their policy rates in response to an unanticipated increase in inflation during times when global financial cycle strength is low, but their responses are muted when financial cycle strength is high. Finally, we show that capital controls, macroprudential policies, and a flexible exchange rate regime can increase monetary policy independence.

Suggested Citation

  • Friedrich, Christian & Guerin, Pierre & Leiva-León, Danilo, 2021. "Monetary Policy Independence and the Strength of the Global Financial Cycle," CEPR Discussion Papers 16203, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:16203
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    Cited by:

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    2. Kristin J. Forbes, 2021. "The International Aspects of Macroprudential Policy," Annual Review of Economics, Annual Reviews, vol. 13(1), pages 203-228, August.

    More about this item

    Keywords

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    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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