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Federal Reserve Bank of Boston
Supervisory Research and Analysis Working Papers
Monetary Policy Divergence and Net Capital Flows: Accounting for Endogenous Policy Responses
This paper measures the effect of monetary tightening in key advanced economies on net capital flows around the world. Measuring this effect is complicated by the fact that the domestic monetary policies of affected economies respond endogenously to the foreign tightening shock. Using a structural VAR framework with quarterly panel data we estimate the impulse responses of domestic policy variables and net capital flows to a foreign monetary tightening shock. We find that the endogenous response of domestic monetary policy depends on each economy's capital account openness and exchange rate regime. We use a method to compute counterfactual impulse responses for net capital outflows under the assumption that the domestic policy rate does not respond to foreign monetary tightening. Our results suggests that failing to account for the endogenous response of domestic monetary policy biases down the estimated elasticity of net capital flows to foreign interest rates by as much as one-third for countries with open capital accounts.
Cite this item
Scott Davis & Andrei Zlate, Monetary Policy Divergence and Net Capital Flows: Accounting for Endogenous Policy Responses, Federal Reserve Bank of Boston, Supervisory Research and Analysis Working Papers RPA 18-5, 27 Sep 2018.
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
- F3 - International Economics - - International Finance
- F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
Keywords: trilemma; structural VAR; counterfactual VAR; net capital inflows; exchange rates
This item with handle RePEc:fip:fedbqu:rpa18-5
is also listed on EconPapers
For corrections, contact Andrei Zlate ()