International cooperation by central banking institutions : when and how is monetary policy coordination feasible?

Abstract

This work analyses the possibility of welfare gains from monetary policy cooperation, against the background of globalization, or increased economic and financial interdependence. A survey of studies shows that gains from cooperation are a function of economic interdependence, market imperfections, and asymmetry in shocks. Time series analysis shows that the United States and the Euro Area are indeed interlinked in both short term money markets and in long term stock markets, satisfying the first condition above. Although nominal rigidity is higher in the Euro Area, shocks to headline inflation seem to be common to both economies. Despite relatively rigid labour markets, it is discussed that a quantitative nominal anchor, such as that of 'below but close to 2%' for the Euro Area, was shown in other studies to reduce inflation volatility in the wake of such shocks. Policymakers in the United States are recommended to likewise announce a numerical target for price stability. In total not all conditions seem to be satisfied, and although some theoretical gains have been reported, at the current level of integration strict monetary policy cooperation may be too constraining. In the presence of imperfect markets and near-rational individuals, central banking is mostly the art and science of managing expectations.