How Might EME Central Banks Respond to the Influence of Global Monetary Factors?
26 Pages Posted: 7 Oct 2014
Date Written: August 2014
Easy monetary conditions in advanced economies have played an important role in determining domestic monetary conditions in emerging market economies (EMEs), notably through the exchange rate and domestic bond yields. How can EME central banks best react to such external influences? Using a small, highly stylised and non-structural monetary policy model, we show that setting the policy interest rate in response to movements in the exchange rate and the yield on domestic long-term bonds – in addition to focusing on more traditional domestic variables such as the output gap and the inflation gap – can make monetary policy more effective. But there are important caveats and trade-offs, notably with respect to uncertainty about the structure of the economy and opposing effects of exchange rates and bond yields on domestic monetary conditions.
Keywords: Emerging market economies, monetary policy, exchange rate, bond yields
JEL Classification: E43, E 52, E58, F31, F36, F42
Suggested Citation: Suggested Citation