Degree of openness international monetary transmission and spillovers

Abstract

Monetary policy contagion has been an important open-macroeconomic phenomenon which newlinehas affected the policy-making of central bankers worldwide, irrespective of their open newlinemacroeconomic choices with respect to Mundellian trilemma. In accordance with Mundellian trilemma, an economy can exercise only two out of the three open-macroeconomic choices, newlinei.e., monetary independence, exchange rate stability and capital openness. Since, open capital accounts have become a norm in the recent times, economies have shifted to varying degree of exchange rate flexibility to enable monetary autonomy in their respective economies, in the last decade. Thus, majority of economies nowadays have either flexible exchange rates or newlinemanaged float exchange rates, in an order to exercise monetary autonomy. However, the recent empirical literature argues that the domestic policy rates in small open economies are quite newlinesensitive to monetary shocks originating in the center economy (loss of monetary autonomy)irrespective of the exchange rate regime they follow. This imposes limits on the extent of newlinemonetary policy autonomy that the central bank of a periphery economy can exercise. Various explanations have been forwarded to explain this inability of flexible exchange rates to insulate monetary autonomy. In brief, fear of floating (Calvo and Reinhart, 2002a; Hausmann, Panizza, and Stein, 2001), and global financial cycle (Helene Rey and Agrippino, 2015) have been benefits of flexible exchange rates have been on table. A thorough study of the literature brings newlineout various research gaps in the field of international monetary transmission, which have not newlinebeen investigated yet, but are quite relevant in the present discussion. Our investigation of few newlinesuch important gaps is distributed in three separate studies and have been summarized belowidentified as the most important reasons for weakening insulation of exchange rates against external influences.