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

Abstract

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

Suggested Citation

ter Ellen, Saskia and Jansen, Edvard and Midthjell, Nina L., ECB Spillovers and Domestic Monetary Policy Effectiveness in Small Open Economies (September 25, 2018). Norges Bank Working Paper 9/2018; ISBN 978-82-8379-052-8. Available at SSRN: https://ssrn.com/abstract=3334905 or http://dx.doi.org/10.2139/ssrn.3334905

Saskia Ter Ellen (Contact Author)

Norges Bank ( email )

P.O. Box 1179
Oslo, N-0107
Norway

Edvard Jansen

Formuesforvaltning ( email )

Nina L. Midthjell

Norges Bank ( email )

P.O. Box 1179
Oslo, N-0107
Norway

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