Monetary policy, economic liberalisation and the current account

13 May 2015
12:30  - 13:30

Ida Hjortsoe, Bank of England



What impact monetary policy has on the current account is unsettled. We examine the transmission of monetary policy to the current account both theoretically and empirically. Our theoretical open economy DSGE model predicts that the current account response to a monetary policy shock depends on the degree of financial, product and labour market liberalisation. In particular, our model shows that while financial liberalisation makes it more likely that the current account deteriorates following a monetary expansion, product market liberalisation makes it more likely to improve. We test these predictions with a varying coefficient Bayesian panel VAR model, where the coefficients are allowed to stochastically vary as a function of the degree of financial, product and labour market liberalisation on data from 1976Q1-2006Q4 for 13 OECD countries. Our empirical results support the findings from the DSGE model. We therefore conclude that following a monetary policy expansion, the current account is more likely to into deficit (surplus) in countries with more liberalised financial (product) markets.


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