Monetary Policy in an Unbalanced Global Economy

• Authors: Luca Fornaro.
• BSE Working Paper: 112288 | January 22
• Keywords: Capital flows , global Inflation , sectoral Reallocation , international monetary cooperation , global supply shortages , competitive exchange rate appreciations , trade imbalances.
• JEL codes: E32, E44, E52, F41, F42
• Capital flows
• global Inflation
• sectoral Reallocation
• international monetary cooperation
• global supply shortages
• competitive exchange rate appreciations
• trade imbalances.

We study optimal monetary policy during times of exceptionally high global demand for tradable goods, relative to non-tradable ones. The optimal monetary response entails a rise in in ation, which helps rebalance production towards the tradable sector. While the in ation costs are fully bore domestically, however, the gains in terms of higher supply of tradable goods partly spill over to the rest of the world. National central banks may thus fall into a coordination trap, and implement an excessively tight monetary policy causing an unnecessarily sharp global contraction.