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Conference Paper: Optimal Monetary Policy in a Currency Union with Interest Rate Spreads

TitleOptimal Monetary Policy in a Currency Union with Interest Rate Spreads
Authors
KeywordsCurrency union
Optimal monetary policy
Monetary policy transmission mechanism
Redistributive monetary policy
Policy trade-offs
Sticky prices
Financial frictions
Interest rate spreads
Spread-adjusted Taylor rule
Issue Date2013
Citation
The 2013 EABCN Conference on Global Spillovers and Economic Cycles, Paris, France, 30-31 May 2013. How to Cite?
AbstractWe study optimal monetary policy in a two-country currency union model with nominal and financial frictions. In addition to, and independent from, the standard transmission mechanism associated with sticky prices, financial frictions combined with asymmetric asset positions introduce a wealth redistribution role for monetary policy in our model. Financial frictions also lead to a spread between the deposit and borrowing interest rate and variation in the spread affects both aggregate variables, by affecting total spending, and relative (cross-country) variables, by redistributing wealth across countries. Moreover, the interactions between nominal and financial frictions amplify the effects of monetary policy; imply that a strict inflation targeting policy of setting union-wide inflation to zero is never optimal and that optimal policy never attains efficiency; and lead to a novel policy trade-o¤ for the central bank in stabilizing relative consumption versus the relative price gap (the deviation of relative prices from their efficient level). Finally, under optimal monetary policy, in response to an aggregate purely financial shock that causes an increase in the interest rate spread, the central bank strongly decreases the deposit rate, which reduces aggregate and distributional inefficiencies by mitigating the drop in output and inflation and the rise in relative consumption and prices. We also show that while a traditional Taylor rule approximates optimal policy imperfectly, especially in response to the financial shock, a spread-adjusted Taylor rule performs better as it helps the real interest rate track the efficient rate of interest.
DescriptionA Euro Area Business Cycle Network (EABCN) Conference
Poster Session 1
The Conference papers' website is located at http://dev3.cepr.org/meets/wkcn/1/1806/papers/default.htm
Persistent Identifierhttp://hdl.handle.net/10722/188031

 

DC FieldValueLanguage
dc.contributor.authorBhattarai, Sen_US
dc.contributor.authorLee, JWen_US
dc.contributor.authorPark, WYen_US
dc.date.accessioned2013-08-21T07:25:51Z-
dc.date.available2013-08-21T07:25:51Z-
dc.date.issued2013en_US
dc.identifier.citationThe 2013 EABCN Conference on Global Spillovers and Economic Cycles, Paris, France, 30-31 May 2013.en_US
dc.identifier.urihttp://hdl.handle.net/10722/188031-
dc.descriptionA Euro Area Business Cycle Network (EABCN) Conference-
dc.descriptionPoster Session 1-
dc.descriptionThe Conference papers' website is located at http://dev3.cepr.org/meets/wkcn/1/1806/papers/default.htm-
dc.description.abstractWe study optimal monetary policy in a two-country currency union model with nominal and financial frictions. In addition to, and independent from, the standard transmission mechanism associated with sticky prices, financial frictions combined with asymmetric asset positions introduce a wealth redistribution role for monetary policy in our model. Financial frictions also lead to a spread between the deposit and borrowing interest rate and variation in the spread affects both aggregate variables, by affecting total spending, and relative (cross-country) variables, by redistributing wealth across countries. Moreover, the interactions between nominal and financial frictions amplify the effects of monetary policy; imply that a strict inflation targeting policy of setting union-wide inflation to zero is never optimal and that optimal policy never attains efficiency; and lead to a novel policy trade-o¤ for the central bank in stabilizing relative consumption versus the relative price gap (the deviation of relative prices from their efficient level). Finally, under optimal monetary policy, in response to an aggregate purely financial shock that causes an increase in the interest rate spread, the central bank strongly decreases the deposit rate, which reduces aggregate and distributional inefficiencies by mitigating the drop in output and inflation and the rise in relative consumption and prices. We also show that while a traditional Taylor rule approximates optimal policy imperfectly, especially in response to the financial shock, a spread-adjusted Taylor rule performs better as it helps the real interest rate track the efficient rate of interest.-
dc.languageengen_US
dc.relation.ispartofEABCN Conference on Global Spillovers and Economic Cycles 2013en_US
dc.rightsCreative Commons: Attribution 3.0 Hong Kong License-
dc.subjectCurrency union-
dc.subjectOptimal monetary policy-
dc.subjectMonetary policy transmission mechanism-
dc.subjectRedistributive monetary policy-
dc.subjectPolicy trade-offs-
dc.subjectSticky prices-
dc.subjectFinancial frictions-
dc.subjectInterest rate spreads-
dc.subjectSpread-adjusted Taylor rule-
dc.titleOptimal Monetary Policy in a Currency Union with Interest Rate Spreadsen_US
dc.typeConference_Paperen_US
dc.identifier.emailPark, WY: wypark@hku.hken_US
dc.identifier.authorityPark, WY=rp01552en_US
dc.description.naturepostprint-
dc.identifier.hkuros220192en_US
dc.customcontrol.immutablesml 140520-

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