ECB Spillovers and Domestic Monetary Policy Effectiveness in Small Open Economies
43 Pages Posted: 15 Feb 2019 Last revised: 29 Jul 2019
Date Written: September 25, 2018
In this paper, we examine whether financial spillovers from the European Central Bank's monetary policy have consequences for the effectiveness of domestic monetary policy in small open economies. Recent work suggests that the trilemma in international economics as we used to know it, is actually a dilemma: even with floating exchange rate regimes, small open economies can only have effective monetary policies when the capital account is managed. We find that although domestic monetary policy seems to be effective for the shorter end of the yield curve, ECB spillover effects reduce domestic control over the longer end of the curve. In the dilemma/trilemma debate, this result leans towards a dilemma: the transmission channel of domestic monetary policy decisions operates through the whole yield curve and hence is weakened considerably if the medium to long term lending and bond rates are little affected.
Keywords: monetary policy effectiveness, global financial cycle, international spillovers, asset prices, small open economies
JEL Classification: E43, E44, E52, E58, G12
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