Monetary Policy in an Equilibrium Portfolio Balance Model

33 Pages Posted: 12 Apr 2007

See all articles by Michael Kumhof

Michael Kumhof

CEPR

Stijn Van Nieuwerburgh

Columbia University Graduate School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); ABFER

Multiple version iconThere are 2 versions of this paper

Date Written: April 2007

Abstract

Standard theory shows that sterilized foreign exchange interventions do not affect equilibrium prices and quantities, and that domestic and foreign currency denominated bonds are perfect substitutes. This paper shows that when fiscal policy is not sufficiently flexible in response to spending shocks, perfect substitutability breaks down and uncovered interest rate parity no longer holds. Government balance sheet operations can be used as an independent policy instrument to target interest rates. Sterilized foreign exchange interventions should be most effective in developing countries, where fiscal volatility is large and where the fraction of domestic currency denominated government liabilities is small.

JEL Classification: E42, F41

Suggested Citation

Kumhof, Michael and Van Nieuwerburgh, Stijn, Monetary Policy in an Equilibrium Portfolio Balance Model (April 2007). IMF Working Paper No. 07/72, Available at SSRN: https://ssrn.com/abstract=979026

Michael Kumhof (Contact Author)

CEPR ( email )

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Stijn Van Nieuwerburgh

Columbia University Graduate School of Business ( email )

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HOME PAGE: http://https://www0.gsb.columbia.edu/faculty/svannieuwerburgh/

National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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ABFER ( email )

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