Chapter

Current Account Dynamics and Monetary Policy

Edited by Andrea Ferrero, Mark Gertler and Lars E. O. Svensson

in International Dimensions of Monetary Policy

Published by University of Chicago Press

Published in print March 2010 | ISBN: 9780226278865
Published online February 2013 | e-ISBN: 9780226278872 | DOI: http://dx.doi.org/10.7208/chicago/9780226278872.003.0005
Current Account Dynamics and Monetary Policy

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This chapter examines the implications of current account adjustment for monetary policy. A two-country monetary dynamic stochastic general equilibrium (DSGE) model with nominal rigidities and incomplete international financial markets to study the role of global imbalances is developed. The framework is initialized to match the recent U.S. account deficit and its overall indebtedness with respect to the rest of the world. It is found that good monetary management can significantly mitigate any pain from current account adjustment. A policy that works well under either the slow or fast burn scenarios is domestic inflation targeting. By contrast, attempts to peg the exchange under the fast burn can lead to considerable damage to the economy. On the other hand, consumer price index (CPI) inflation targeting is relatively harmful under full exchange rate pass-through, but not so much when the latter is partial.

Keywords: current account; monetary policy; dynamic stochastic general equilibrium; DSGE; financial markets; monetary management

Chapter.  18649 words.  Illustrated.

Subjects: Macroeconomics and Monetary Economics

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