Financial stability in open economies

Do financial frictions call for policy cooperation? This paper investigates the implications of
financial frictions for monetary policy in the open economy. Welfare analysis shows that there
are long-run gains which result from cooperation, but, dynamically, financial frictions per se do
not require policy cooperation to improve global welfare over business cycles. In addition,
inward-looking financial stability, namely eliminating inefficient fluctuations of loan premiums in
the home country, is the optimal monetary policy in the open economy, irrespective of the
existence of policy coordination.