Portfolio Preference Uncertainty and Gains from Policy Coordination

Abstract

International policy coordination is generally considered to be made less likely – and less profitable – by uncertainty about how the economy works. This paper offers a counter example, in which investors' increased uncertainty about portfolio preference makes coordination more beneficial. Without such coordination, monetary authorities may respond to financial market uncertainty by not fully accommodating demands for increased liquidity, for fear of inducing exchange rate depreciation. Coordinated monetary expansion would minimize this danger. This result is formalized in a model incorporating an equity market; then, the stock market crash of October 1987 and its implications for monetary policy coordination are discussed.