Portfolio Preference Uncertainty and Gains from Policy Coordination

Abstract

International macroeconomic policy coordination is generally considered to be made less likely--and less profitable--by the presence of uncertainty about how the economy works. The present paper provides a counter-example, in which increased uncertainty about portfolio preference of investors makes coordination of monetary policy more beneficial. In particular, In the absence of coordination monetary authorities may respond to financial market uncertainty by not fully accommodating demands for Increased liquidity, for fear of bringing about exchange rate depreciation. Coordinated monetary expansion would minimize this danger. A theoretical model incorporating an equity market is developed, and the stock market crash of October 1987 is discussed in the light of its implications for monetary policy coordination.