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Globalisation, Pass-through and the Optimal Policy Response to Exchange Rates

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  • Michael B. Devereux
  • James Yetman

Abstract

In this paper we examine how monetary policy should respond to nominal exchange rates in a New Keynesian open economy model that allows for a non-trivial role for sterilised intervention. The paper develops the argument against the backdrop of the evolving policy-making environment of Asian economies. Sterilised intervention can be a potent tool that offers policymakers an additional degree of freedom in maximising global welfare. We show that the gains to sterilised intervention are greater when goods market integration is low and exchange rate pass-through is high. However, increased financial internationalisation reduces the effectiveness of sterilised intervention, as the international policy trilemma becomes more relevant. Unsterilised intervention may also have a role to play, although the potential welfare gains from this are generally smaller. Most central banks in Asia have actively used sterilised foreign exchange intervention as a policy tool to smooth exchange rates. But, over time, declining exchange rate pass-through and the increasing international integration of financial and goods markets will tend to reduce the efficacy of sterilised intervention. Given the limited effectiveness of unsterilised intervention, our model implies that the role of exchange rate movements in the optimal setting of monetary policy in Asia is decreasing.

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  • Michael B. Devereux & James Yetman, 2014. "Globalisation, Pass-through and the Optimal Policy Response to Exchange Rates," NBER Working Papers 20252, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:20252
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    Cited by:

    1. Amador, Manuel & Bianchi, Javier & Bocola, Luigi & Perri, Fabrizio, 2017. "Exchange Rate Policies at the Zero Lower Bound," Working Papers 740, Federal Reserve Bank of Minneapolis.
    2. Nidhaleddine Ben Cheikh & Christophe Rault, 2017. "Investigating first-stage exchange rate pass-through: Sectoral and macro evidence from euro area countries," The World Economy, Wiley Blackwell, vol. 40(12), pages 2611-2638, December.
    3. Pierre-Richard Agénor & K. Alper & L. Pereira da Silva, 2015. "External Shocks, Financial Volatility and Reserve Requirements in an Open Economy," Working Papers Series 396, Central Bank of Brazil, Research Department.
    4. Agénor, Pierre-Richard & Alper, Koray & Pereira da Silva, Luiz A., 2014. "Sudden floods, macroprudential regulation and stability in an open economy," Journal of International Money and Finance, Elsevier, vol. 48(PA), pages 68-100.
    5. Pym Manopimoke, 2015. "Globalization and International Inflation Dynamics: The Role of the Global Output Gap," PIER Discussion Papers 8., Puey Ungphakorn Institute for Economic Research, revised Nov 2015.
    6. Wanicha Direkudomsak, 2016. "Inflation dynamics and inflation expectations in Thailand," BIS Papers chapters,in: Bank for International Settlements (ed.), Inflation mechanisms, expectations and monetary policy, volume 89, pages 349-360 Bank for International Settlements.
    7. Hao Jin, 2015. "Foreign Exchange Interventions, Capital Controls and Monetary Policy: The Case of China," Caepr Working Papers 2015-019 Classification-D, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
    8. repec:eee:jimfin:v:83:y:2018:i:c:p:23-43 is not listed on IDEAS
    9. Disyatat, Piti & Rungcharoenkitkul, Phurichai, 2017. "Monetary policy and financial spillovers: Losing traction?," Journal of International Money and Finance, Elsevier, vol. 74(C), pages 115-136.
    10. Ippei Fujiwara, 2014. "Comments on Michael Devereux and James Yetman's paper," BIS Papers chapters,in: Bank for International Settlements (ed.), Globalisation, inflation and monetary policy in Asia and the Pacific, volume 77, pages 119-125 Bank for International Settlements.
    11. Georgiadis, Georgios & Mehl, Arnaud, 2016. "Financial globalisation and monetary policy effectiveness," Journal of International Economics, Elsevier, vol. 103(C), pages 200-212.
    12. Michael B Devereux & James Yetman, 2014. "Responding to exchange rates in a globalised world," BIS Papers chapters,in: Bank for International Settlements (ed.), Globalisation, inflation and monetary policy in Asia and the Pacific, volume 77, pages 97-117 Bank for International Settlements.
    13. Ken Miyajima & Madhusudan Mohanty & James Yetman, 2014. "Spillovers of US unconventional monetary policy to Asia: the role of long-term interest rates," BIS Working Papers 478, Bank for International Settlements.
    14. Sheng Wang & Rufei Guo, 2016. "Asymmetric Exchange Rate Pass-through and Monetary Policy in Open Economy," Annals of Economics and Finance, Society for AEF, vol. 17(1), pages 33-53, May.
    15. repec:eee:reveco:v:51:y:2017:i:c:p:245-257 is not listed on IDEAS
    16. Georgiadis, Georgios & Mehl, Arnaud, 2015. "Trilemma, not dilemma: financial globalisation and Monetary policy effectiveness," Globalization and Monetary Policy Institute Working Paper 222, Federal Reserve Bank of Dallas.

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    JEL classification:

    • F3 - International Economics - - International Finance
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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