Macroeconomics Seminar - Anna Lipinska (Federal Reserve Board)

Title: A Welfare-Based Analysis of International Monetary Policy Spillovers at the Zero Lower Bound

Abstract: We study the welfare effects of international monetary policy spillovers at the zero lower bound, focusing on the effects of forward guidance in a large economy (“foreign”) on its smaller trading partner (“home”). We find that when foreign forward guidance has an overall prosper-thy-neighbor effect on the home economy as long as it increases foreign welfare. Foreign forward guidance—when stabilizing the foreign economy—has a large direct positive effect on home welfare that dominates overall home welfare effect. However, foreign forward guidance may worsen the trade-off between the stabilization objectives of home monetary policy. This occurs when foreign forward guidance leads to higher home inflation and a more negative output gap on account of the expenditure switching effect more than offsetting the aggregate demand effect. In this case, the optimal home monetary policy response to foreign guidance is to be more accommodative.