2024-03-28-IMF-Central_Bank_Exit_Strategies_Domestic_Transmission_and_International_Spillovers_57页_1mb

Central Bank Exit Strategies: Domestic Transmission and International Spillovers Summary

Authors: Christopher Erceg, Marcin Kolasa, Jesper Lindé, Haroon Mumtaz, Pawel Zabczyk
IMF Working Paper: WP/24/73
Date: March 2024

Key Findings:

1. Domestic Transmission of Monetary Policy:

• Quantitative Easing (QE) vs. Conventional Policy:
  • QE has a stronger effect on the exchange rate and term premium but a relatively smaller impact on domestic output compared to conventional short-term rate cuts, when normalized by their effects on long-term yields.
  • QE is more effective in stimulating output during a liquidity trap due to the effective lower bound (ELB) constraint on conventional rates.
  • Quantitative Tightening (QT), or asset sales, has a persistently negative impact on the exchange rate and is associated with a subdued economic response.

2. International Spillovers:

• Conventional Tightening vs. Quantitative Tightening (QT):
  • Tightening via conventional interest rate hikes has fewer negative spillovers compared to QT.
  • QT triggers an inflation-output trade-off in recipient economies through exchange rate depreciation and term premium increases, especially in emerging market economies (EMEs).
  • The spillover effects are amplified in EMEs and especially under fixed exchange rate regimes.

3. Model-Based Insights:

• New Keynesian DSGE Model: Incorporates segmented asset markets, cognitive discounting, and strategic complementarities in pricing.
• Policy Effectiveness:
  • QE and conventional policy yield similar domestic outcomes, but QT exacerbates spillovers.
  • Cognitive discounting reduces the potency of forward guidance, making QE the primary tool in deep liquidity traps.

4. Policy Recommendations:

• Conventional monetary policy normalization (interest rate hikes) is preferred due to reduced negative cross-border spillovers.
• Careful calibration is needed for emerging market economies, particularly under fixed exchange rate regimes.

Conclusion:

The study emphasizes that central banks should prioritize conventional policy tools to mitigate adverse international effects during normalization. Quantitative tightening poses significant risks to monetary stability in recipient economies, especially in EMEs.