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The Elusive Gains from Nationally-Oriented Monetary Policy

25 September 2019 at 12:00 PM - 2:00 PM

Room 207, Campus on Viale Romania, 32

Speaker: Martin Bodenstein , FED

Abstract:

 Joint with Giancarlo
Corsetti and Luca Guerrieri.

The consensus in recent macro literature is that gains from international monetary cooperation are likely to be small. While this irrelevance result holds for economies which are close to ``internal'' and ``external balance,'' we show that the welfare costs and incentives to move away from cooperation can be very large when assessed conditionally on empirically-relevant dynamic developments of the economy. Using the workhorse two-country, two-good monetary model with nominal rigidities, we find that, in bond economies, the temptation to pursue non-cooperative, nationally-oriented policies is primarily driven by the emergence of global imbalances, i.e. large net foreign assets positions. Under complete markets, the temptation to deviate from cooperation is increasing in the trade-offs between inflation and unemployment, as is the case when price and wage rigidities translate into large and divergent real wage distortions. Quantitatively, the conditional costs of nationally-oriented policies can climb to several times the costs associated with business cycle fluctuations. We also show that flexible inflation targeting comes close to replicating the cooperative policies, and thus it is just as fragile.