Giancarlo Corsetti, Keith Kuester, Gernot Müller, Sebastian Schmidt, 27 January 2021

Recent evidence suggests flexible exchange rates do not always insulate economies from external shocks. This column provides novel evidence on how shocks that originate in the euro area spill over to its neighbour countries. In response to euro area shocks economic activity in the neighbour countries contracts as much as in the euro area – not only in countries that peg their currency to the euro, but also in those with a flexible exchange rate. It shows that a standard open economy model predicts this lack of insulation for floating exchange rates, provided the central bank targets CPI inflation. 

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Exchange rates movements are again attracting a lot of attention as a focal point in the policy debate. Prolonged recession following the global financial crisis has pushed most advanced economies into liquidity traps where domestic monetary policy is severely limited. The exchange rate offers an alternative option for boosting aggregate demand in a liquidity trap. However, the exchange rate channel may have global repercussions through spillover effects on international goods and financial markets. Emerging market policymakers, in particular, have raised warnings about excessive exchange rate movements arising from advanced economy stimulus. A further risk arises from the exchange rate implications of US monetary policy `normalization’. This conference hopes to bring together new empirical and theoretical research on all aspects of exchange rates, their role in domestic macroeconomic policy as well as the global trade and financial system.

Sebastian Edwards, 04 February 2015

The conventional ‘trilemma’ view is that countries that allow free capital flows can still pursue independent monetary policies as long as they allow flexible exchange rates. This column examines the pass-through of Federal Reserve interest rates to policy rates in Chile, Colombia, and Mexico. The author concludes that, to the extent that central banks take into account other central banks’ policies, there will be ‘policy contagion’ and that, even under flexible rates, monetary policy will not be fully independent.

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