General Description
This is a three day seminar primarily aimed at participants in the Euro Area Business Cycle Network but applications will also be considered from doctoral students, post-doctoral researchers and economists working in central banks and government institutions outside of the network, as well as commercial organisations (fees applicable for non-network organisations).
Course Detail
This course aims to introduce participants to the state-of-the-art modelling of monetary policy trade-offs in open economies. The course develops workhorse monetary model of open economies to gain insights into two emerging policy issues: the optimal policy response to capital flows; macro stabilization in a sovereign risk crisis. The course is structured in three parts.
Part I: Building Blocks and review of the literature
This initial part of the course reconsiders the standard new-Keynesian workhorse model of monetary policy, with the goal of deriving (a) a general version of the Phillips Curve, encompassing economies with complete and incomplete markets, and alternative specifications of the nominal rigidities in import prices; and (a) a general policy loss function, bringing forward a modern version of ‘internal’ and ‘external’ objectives of stabilization policies. Solving for the optimal policy problem, we will characterize optimal targeting rules in the presence of nominal and financial frictions.
The bulk of the literature using the standard model has worked out policy-problems exploring the policy implications of import/export price stickiness. To review the literature, we will provide a generalization of its main results concerning exchange rate flexibility and deviation from strict inflation targeting, and discuss general issues in modelling local-currency price stability of imports.
Part II: Monetary Policy Trade-offs Associated with Capital Flows
In this part of the course, we will focus on policy trade-offs raised by large capital flows into economies characterized by basic financial imperfections, and study conditions under which these are associated with overappreciation and overheating. A key question is whether the optimal targeting rules prescribe a contractionary stance, to address overheating, or an expansionary stance, to lean against real appreciation. For some specifications of the model adopted in leading contribution to the literature, we will be able to characterize the optimal policy rules and the dynamics of the economy analytically.
As a general result, optimal policy is consistent with flexible inflation targeting, putting some weight on internal (e.g. output gap) and external (e.g. exchange rate misalignment and capital flows) stabilization. The optimal response however varies systematically with trade and intertemporal elasticities, openness, and the degree of exchange rate pass-through in import prices.
The analysis qualifies the hypothesis, according to which external imbalances should be viewed as a manifestation of overheating: in reaction to widening deficits, central banks should adopt contractionary policy. It sheds light on the desirability of commitment in improving the short run trade-off between inflation and employment in response to capital inflows, unveiling a fundamental analogy with the stabilization of markup shocks. It raises issues in international policy coordination, whereas cooperative policies may be mainly motivated by the goal of supporting output and welfare abroad.
Part III: Topics: Fiscal and Monetary Interactions
In the concluding part of the course, we will discuss issues in fiscal and monetary policy mix. We will first provide an analytical characterization of fiscal transmission under flexible and fixed prices, addressing the conventional wisdom, according to which fiscal policy is more effective under a peg. We will then allow for a zero-lower bound constraint, and discuss directions for policy-oriented research on the macroeconomic causes and implications of sovereign risk.
About the instructors:
Giancarlo Corsetti is Professor of Macroeconomics at Cambridge University since 2010, previously at the European University Institute, Rome and Yale. His research focuses on open macro macroeconomics and international economics. He obtained his PhD. from the University of Yale. He is a consultant at the Bank of England and the European Central Bank.
Simon Lloyd is Ph.D. researcher at the University of Cambridge. His research focuses on monetary and applied macroeconomics.