Financial Globalization and Monetary Transmission

Abstract

This paper analyzes the way in which international financial integration affects the transmission of monetary policy in a New Keynesian open economy framework. It extends Woodford's (2010) analysis to a model with a richer financial markets structure, allowing for international trading in multiple assets and subject to financial intermediation costs. Two different forms of financial integration are considered, in particular an increase in the level of gross foreign asset holdings and a decrease in the costs of international asset trading. The simulations in the calibrated model show that none of the analyzed forms of financial integration undermine the effectiveness of monetary policy in influencing domestic output and inflation. Under realistic parameterizations, monetary policy is more, rather than less, effective as the positive impact of strengthened exchange rate and wealth channels more than offsets the negative impact of weakened interest rate channels. The paper also analyzes the interaction of financial integration with trade integration, varying both the importance of trade linkages and the degree of exchange rate pass-through. These interactions show that the positive effects of financial integration are amplified by trade integration. Overall, monetary policy is most effective in parameterizations with the highest degree of both financial and real integration. JEL codes: E52, F41, F42, F47

Monetary Policy and its Transmission in a Globalised World

“…In response to an appreciation of the home currency triggered by a tightening of domestic monetary policy, the home currency price of foreign assets falls. This wealth effect depresses domestic spending, amplifying the domestic effects of the monetary policy tightening through the aggregate demand channel (Meier, 2013). At the same time, the foreign currency value of the home economy's foreign liabilities held by the rest of the world increases in response to this currency appreciation.…”

Trilemma revisited with dollar dominance in trade and finance

“…Using a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model, Meier et al. (2013) shows that monetary policy has more potent effects in economies with a net long in foreign currency.…”

“…Indeed, if a country has a large amount of foreign-denominated debt, a local currency depreciation leads to an increase in the cost of credit and a contraction in economic activity. Using a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model, Meier et al (2013) shows that monetary policy has more potent effects in economies with a net long in foreign currency.…”

The Impact of Financial Liberalization on the Effectiveness of Monetary Policy in Algeria

“…In addition, the liberalization of financial markets increases the acquisition of foreign assets by domestic investors and strengthens (foreign) wealth channels for monetary transfer and increases the control of monetary policy on domestic spending as deregulation enhances the impact of exchange rate assessment (caused by monetary policy) on foreign income for the local investor and his wealth. Hence, this form of liberalization enhances (foreign) wealth channels for the transmission of monetary policy (Meier, 2013).…”