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Financial openness, financial frictions and optimal monetary policy

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  • Ester Faia

    (Goethe University Frankfurt, CEPREMAP - Centre pour la recherche économique et ses applications - ECO ENS-PSL - Département d'économie de l'ENS-PSL - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres)

  • Eleni Iliopulos

    (CEPREMAP - Centre pour la recherche économique et ses applications - ECO ENS-PSL - Département d'économie de l'ENS-PSL - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres, CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)

Abstract

Increasing financial integration challenges the optimality of inward-looking strategies for optimal monetary policy. Those issues are analyzed in an open economy where foreign net lending, and the current account, are determined by a collateral constraint. Durables represent collateral. The current account features persistent imbalances, but can deliver a long run stationary equilibrium. The comparison between floating and managed exchange rate regimes shows that the impossible trinity is reversed: higher financial integration increases the persistence and volatility of the current account and calls for exchange rate stabilization. In this context, the Ramsey plan too prescribes stabilization of the exchange rate, alongside with domestic inflation.

Suggested Citation

  • Ester Faia & Eleni Iliopulos, 2011. "Financial openness, financial frictions and optimal monetary policy," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-00628737, HAL.
    • Handle: RePEc:hal:cesptp:hal-00628737
    DOI: 10.1016/j.jedc.2011.06.012
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    Cited by:

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    3. Bosupeng, Mpho, 2015. "The Impossible Trinity and Financial Markets – An Examination of Inflation Volatility Spillovers," MPRA Paper 77923, University Library of Munich, Germany, revised 2015.
    4. Aliya Algozhina, 2012. "Monetary and Fiscal Policy Interactions in an Emerging Open Economy: A Non-Ricardian DSGE Approach," CERGE-EI Working Papers wp476, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    5. Marco Riguzzi & Philipp Wegmueller, 2017. "Economic Openness and Fiscal Multipliers," International Economic Journal, Taylor & Francis Journals, vol. 31(1), pages 1-35, January.
    6. Ma, Yong & Jiang, Yiqing & Yao, Chi, 2022. "Trade openness, financial openness, and macroeconomic volatility," Economic Systems, Elsevier, vol. 46(1).
    7. Yong Ma & Yiqing Jiang, 2023. "Gradual financial integration and macroeconomic fluctuations in emerging market economies: evidence from China," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 18(2), pages 275-310, April.

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    More about this item

    Keywords

    Global imbalances; Collateral constraints; Monetary regimes;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F1 - International Economics - - Trade

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