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The Transmission Mechanism of Monetary Policy: Evidence from the Caribbean
Abstract
This paper presents an empirical analysis of the monetary transmission mechanism in four Caribbean countries: Jamaica, Trinidad and Tobago, Barbados and Guyana. This research is timely since little is known about the transmission mechanism of monetary policy in developing countries in general and in the Caribbean in particular. In developing countries financial markets tend to be relatively unsophisticated hence monetary policy is likely to affect the real sector by altering the quantity and availability of credit rather than the price of credit. The results show that the credit and exchange rate channels are more important than the money channel in transmitting impulses from the financial sector to the real sector. The findings can assist policy makers in other developing countries in the design and implementation of monetary policy.
... As a result, lenders will be less willing to offer loans (either by demanding greater risk premia or limiting the amount loaned), causing spending and aggregate demand to fall. (Mishkin, 1995;Ramlogan, 2004). Moreover, due to the fact that the countries under investigation are economically integrated, making them vulnerable to external shocks through import prices, we believe it is necessary to examine the explanatory power of the main external variables in addition to the exchange rate and other monetary policy instruments. ...
... Alavi et al. (2016) demonstrated that macroeconomic responses to commodity price shocks in Africa are heterogeneous in terms of magnitude and direction. (Ramlogan, 2004) investigates the transmission mechanism of monetary policy in developing countries in general and the Caribbean in particular. He argues that because developing country financial markets are relatively unsophisticated, monetary policy is more likely to affect the real sector by changing the quantity and availability of credit rather than the price of credit. ...
As a result of the West African region's continuous political and economic instability, various economies have used monetary policy changes to respond to shocks from macroeconomic causes. Scholars disagree on the mechanisms of monetary policy, external shocks, and macroeconomic activity links in an economy, according to the available literature in both inter-regional and intra-regional evaluations. This article promotes understanding and management of external shocks in monetary policy by focusing on two key goals. (1) To investigate external shocks, macroeconomic performance, and the dynamics of monetary policy in Western African countries. (2) Use the S-VAR method of estimate to investigate the impact of these economic indices on monetary policy dynamics in Nigeria, Ghana, Cameroon, and Niger. The S-VAR method was chosen because it is useful for analysing macroeconomic shocks and monetary policy transmission. The findings reveal that the West African countries are so interconnected, any change in the price of non-oil commodities would have a significant impact on the exchange rate, which will be channelled through policy rates to GDP. We recommend and emphasise the need of diversifying member countries' productive and export bases rather than continuing to rely on one or a few items as the primary source of income.
... Furthermore, many studies on monetary transmission for developing countries were also conducted by those such as Arena et al. (2006), Agung (1998) and Ramlogan (2004). Various channels of monetary transmission are investigated in those countries. ...
... Various channels of monetary transmission are investigated in those countries. The results vary from one country to another, yet all of these studies seem to suggest the existence of credit channel (Ramlogan, 2004;Huang and Pfau, 2008;Ahmad, 2008). Some studies also document on the factors affecting the activeness of the bank lending channel, i.e. size, liquidity and origin of banks (Arena et al., 2006;Agung, 1998). ...
Monetary policy influences the real economy through various channels including the bank lending. Currently, Malaysia is operating under dual banking systems; conventional and Islamic banking. The latter has distinctive feature of interest-free. Hence, this study aims to empirically explore the relevance of Islamic banks' financing in channeling the monetary policy effects to the real economy. To achieve this objective, the study relies on an autoregressive distributed lag (ARDL) bound testing approach and innovation accounting approach, and uses quarterly data spanning from 1991:Q1 to 2010:Q4. The study documents that Islamic financing channel for monetary transmission exists in Malaysia. Islamic financing is unequally distributed to economic sectors in response to monetary policy shock. Furthermore, the findings also reflect that Islamic banking as operating in dual banking system is not spared from the interest rate and monetary conditions of the country. This clearly shows the behavior of Islamic banking which cannot shun away from the interest rate while its operation delinks from the interest rates. In designing monetary policy, the central bank should consider Islamic financing as an alternative or complement channel for monetary transmission since this channel is just as active as conventional lending channel.
... An influential work by Bernanke and Blinder (1992) uses a vector auto regression (VAR) model to show that a contractionary monetary policy induces a decline in bank loans and economic activities. Many researchers have applied this methodology to different countries (Ashcraft 2006;Kakes & Sturm 2002;Ramlogan 2004;Suzuki, 2004). However, their findings are inconsistent in terms of the role of the bank lending channel. ...
... Overall, their results provide support for the existence of a bank lending channel. Ramlogan (2004) shows that the credit and exchange rate channels are more important than the interest rate channel in Caribbean countries. Buigut (2010) tests the lending channel using a vector error correction model in a framework that allows the identification of the shifts of demand and supply schedules in the bank loan market. ...
This study explores how monetary policy changes flow through the banking sector in Australia. Drawing on data between 2004 and 2010, we divide banks into three groups according to their size, and examine the impact of that cash rate change on lending of different types of loans. We find the response of bank lending after a monetary policy change varies with the size of the bank as well as the types of loan. Smaller banks are more sensitive to policy rate changes, and household loans, government loans and intra-group loans are less responsive to monetary policy compared with financial and non-financial loans. © 2014 Australasian Accounting Business and Finance Journal and Authors.
... Many researchers have applied this methodology on different countries (e.g. Suzuki, 2001;Ramlogan, 2004;Ashcraft, 2006;Dungey and Fry, 2010). The findings using this approach are inconsistent in terms of the role of the bank lending channel. ...
... Overall, their results provide support for the existence of a bank lending channel. Ramlogan (2004) shows that the credit and exchange rate channels are more important than the interest rate channel in the Caribbean countries. Buigut (2010) tests the lending channel using a vector error correction model in a frame work that allows the identification of the shifts of demand and supply schedules in the bank loan market. ...
The transmission of monetary policy may hold the key to explaining the effects of policy on the economy. The objective of the study is to assess the importance of the bank lending channel in the transmission of monetary policy in Australia. In this paper, we found that the effectiveness of monetary policy varies with the size of the bank as well as the type of the loan. For different asset size and different kinds of loans, the effect of monetary policy is different. Thus, policy has distributional effects on bank loans that depend on asset size and industry in the economy.
... For example, although Robinson and Robinson (1997) do not specifically trace transmission from monetary policy through bank lending rates to aggregate demand, they found that changes in the repo rate had important short-run effects on both prices and economic activity in Jamaica. More convincingly, Ramlogan (2004), using a structural VAR to examine monetary transmission in three Caribbean countries, found that monetary tightening resulted in a contraction in bank credit that was accompanied by slower growth and lower inflation, consistent with an effective bank lending channel operating in those countries. ...
... The differences in response relate not only to the magnitude but also to the duration of the response. (ii) There can also be differences in the direction of changes in lending ratesRamlogan (2004) Structural VAR (i) In each country except Barbados a shock to loans accounts for over 28 per cent of the variance in output over the long run. (ii) In Barbados although credit shocks are not as important as exchange rate shocks at any time horizon, a shock to loans retains a large role in explaining output variability compared to the role of money shocks. ...
This paper reviews the monetary transmission mechanism in low income countries (LICs). We use monetary transmission in advanced and emerging markets as a benchmark to identify aspects of the transmission mechanism that may operate differently in LICs. In particular, we focus on the effects of financial market structure on monetary transmission. The weak institutional framework prevalent in LICs drastically reduces the role of securities markets and increases the cost of bank lending to private firms. Coupled with imperfect competition in the banking sector, this means that banks with chronically high excess reserves invest in domestic public bonds or (when possible) in foreign bonds. With the financial system not intermediating funds properly, the traditional monetary transmission channels (interest rate, bank lending, and asset price) are impaired. The exchange rate channel, on the other hand, tends to be undermined by central bank intervention in the foreign exchange market. These conclusions are supported by review of the institutional frameworks, statistical analysis, and previous literature.
... For exploring how monetary shocks affect the economy, we employ the VAR methodology, which has been increasingly adopted in recent years (Dabla-Norris and Floerkemeir, 2006;Ramlogan, 2004;Morsink and Bayoumi, 2001). The chief advantage of using standard VAR is that only minimal restrictions need to be imposed. ...
... If there is no contemporaneous feedback from the non-policy variable to policy variable, it is theoretically sound to place the policy variable first in the recursively ordered system. If the contemporaneous correlation among the shocks in the reduced-form VAR is high (Ahmed, 2003;Ramlogan, 2004), ordering becomes a matter of concern. ...
Amongst the South Pacific's least developed small island countries, Samoa has emerged as a successful economy. Its achievements of low inflation and high growth rates have been due to sustained fiscal adjustment programmes and appropriate monetary policy measures. This paper undertakes an empirical study of transmission mechanism of monetary policy by adopting a VAR approach and using quarterly data over a 17-year period (1990-2006). The study findings are that money and exchange rate channels are important channels in transmitting monetary impulses to Samoa's output.
... Numerous of economist and researchers has been devoted on finding evidence for monetary policy effectiveness and its impact on macroeconomic by employing data from difference countries (Mengesha andHolmes, 2013, 2013;Partachi and Mija, 2015). The most frequency mentioned of monetary transmission channels in the previous literature including interest rate channel, credit channel, exchange rate channel, asset price channel and expectation channel (Afandi, 2005;Bhuiyan, 2012;Boivin et al., 2010;Bredin and O'Reilly, 2004;Carlyn, 2004;Loayza and Schmidt-Hebbel, 2002;Maliszewski, 2005;Suzuki, 2004). ...
The empirical analysis of this study examines the effect of monetary policy on economic growth in Lao PDR. This study uses Vector Autoregressive Model (VAR) and quarterly data from the first quarter of 1995 to the last quarter of 2018. The results found that GDP was negatively responding to price level indicates that a shock in monetary policy or when the central bank adopts an expansionary monetary policy will result in consumer price level, and therefore leads to decline on the real output in the Lao economy. Moreover, this study also found negative effect of the real interest on GDP in Lao PDRD.
... Considering Ramlogan (2004), there are two unlike assets present in the money channel, one is money and all other assets. A reduction in the level of reserves prompts a fall in the level of deposits. ...
This study aims to explore the association between managerial
disclosure beliefs and companies’ nature in disclosing information to
the market. It conveys a cognitional aspect that holds beliefs
underlying the performance of behaviors. Therefore, managerial
disclosure beliefs are related to voluntary disclosure practices of a
firm. Managerial disclosure beliefs are measured through a survey
(Stratified Random Sampling) of 73 companies’ (enlisted in Dhaka
Stock Exchange -DSE) CEOs with a questionnaire of 27 belief
statements. Voluntary disclosures of companies are measured from
annual reports (2016-2017) of the selected companies. Factor
analysis is performed to reduce 27 belief statements (independent
variables) to a manageable number of variables (factors). Then
regression analysis is applied to investigate influential factors
affecting voluntary disclosure. The results show that managerial
disclosure beliefs predict more than 55 percent of the variation in the
volume of both earnings and strategy disclosures. Specially, CEOs of
companies who believe that disclosure of self-report, bad news,
reduction of investor’s information gathering cost or reduction cost
of raising capital have certain benefits disclose more than other
companies. Further, CEOs of companies who believe that disclosing
information to market (for example, analysts’ forecast, warning
about bad news etc.) would affect market less likely to disclose
information than those CEOs who do not believe. However, low
disclosure companies were found to have CEOs who believe that the
forecast disclosure exceeds competitive costs, forecast disclosure
harm to managerial reputation, forecast disclosure exceeds union
costs and strategy disclosure exceeds union costs. These results
reflect the importance of managerial disclosure beliefs in explaining
and predicting the nature of voluntary disclosure among companies.
Keywords: Managerial Beliefs, Earnings Disclosure, Strategy
Disclosure, Factor Analysis, Regression Analysis.
... A pre-request of having successful monetary policy strategy is the monetary authorities must have an accurate knowledge on the assessment of timing and effect of their policy on the economy in other word understand the relationship between operating targets and ultimate targets variables. That's means in order to conduct successful monetary policy it require an understanding of the mechanism of transmitting monetary policy through which channel monetary policy affect economy on the specific area (Mishkin 1995, Ramlogan 2006. ...
... Recently, the literature has stressed the importance of bank loans in the transmission mechanism for developing countries, mainly because the economies are dominated by many bank-dependent borrowers (Ramlogan, 2004). Also, Mishra et al. (2010) and Montiel et al. (2012provide theoretical arguments as to why BLC might be more effective in less developed countries than other channels. ...
This study uses dynamic panel data estimation models, employing annual bank-level data spanning the period 2001-2011, to empirically investigate whether or not changes in the monetary policy in Tanzania influence bank lending behaviour, i.e., existence of a bank lending channel (BLC). It also examines the distributional effects of the monetary policy on banks with different balance sheet characteristics and ownership structures.
The findings lend support to the hypotheses that, first: BLC operates in Tanzania, suggesting that bank loans are important channel through which monetary policy shocks are transmitted to the economy. The findings mirror the arguments that the banking sector still dominates the financial system in the country, whereas money, capital, and real estate markets are still at their infant stages. Banks account for about three-quarters of the financial sector’s assets, reflecting their dominance of sources of funding. Meanwhile, about two-thirds of bank funding comes from private sector deposits, probably constraining banks in offsetting the decrease in funds from deposits by raising funds from other sources. Second, banks react asymmetrically to policy changes influenced by size, capital strength, and ownership structure. The lending channel is stronger through domestically-owned banks and privately-owned banks than it is with foreign-owned banks and public-owned banks. The reason is that, for foreign-owned banks, they could enhance their capital through raising of equity abroad and/or benefit from retained earnings; while for public-owned banks, it could be because they are not under pressure to make profit and, therefore, may opt not to cut-down their loans following a monetary policy shock.
The policy implications are that, in assessing the stance of the monetary policy, beside short-term interest rates, it is critical for the monetary authority to trace banks reaction to monetary policy changes as reflected in loan supply to the private sector. Such investigation should also factor in possible asymmetric responses by banks influenced by size, capitalization, as well as ownership structure.
... Much of the literature for the transmission mechanism in developing countries has been on close economy framework. Ramlogan (2004) found interest rate channel comparatively less important than other channels in Jamaica, Trinidad and Tobago, Barbados and Guyana. The study provided an argument that due to the underdeveloped money market in these countries the investors has to rely on banking sector to raise the funds which leads credit channel as highly contributing transmission channel in this regard. ...
The objective of this study is to investigate the relative importance of four transmission channels (i.e. interest rate, credit, exchange rate and asset price channel) of monetary policy in achieving the internal balance for a small open-economy of Pakistan. This study has employed open-economy Structural vector autoregressive (SVAR) model with non-recursive identification. This method is undertaken to analyze the effects of external shocks on the domestic macroeconomic variables and on domestic monetary policy. The shutdown method in SVAR has also been used to gauge the relative importance of each channel. The results show that foreign shocks have contractionary effects on domestic economy and monetary policy. Interest rate channel has been less important on inflation rate than asset price and credit channel, although it is found important in output variations. Exchange rate channel has been found least important in both cases of inflation and output in Pakistan. This study has found that central bank of Pakistan can only utilize interest rate channel when it targets output, whereas to control inflation rate the asset price channel is relatively more useful.
... Likewise, firms may not be inclined to increase borrowing for investment in response to lower interest rate if they do not believe the economy will rebound from a recession. For some empirical evidence, along this line, see Gertler and Gilchrist (1992), Kam and Mohsin (2006) and Ramlogan (2005). Domac and Kandil (2002) consider options to maximize the effectiveness of monetary policy using data for Germany. ...
Using annual data, the paper studies the time-series evidence regarding the allocation of monetary growth shifts between demand components, real growth and price inflation in a sample of developing and advanced countries. The evidence reveals patterns of interaction between demand shifts and the real and inflationary effects of monetary policy. These patterns provide sharp differences in the distribution of monetary shocks across economic variables in developing and advanced countries. The paper evaluates the evidence and draws policy implications regarding potential constraints on monetary policy.
... As a result, fewer deposits are placed by the banks customers (Ford et al., 2003). Ramlogan (2004) asserts that in the money channel there are two classes of assets; money and all other assets. A reduction in the level of reserves prompts a fall in the level of deposits. ...
The objective of this paper is to empirically explore the dynamic inter-relationships between deposits of Islamic banks with monetary policy variables in Bahrain and Malaysia covering the period from January 2001 to June 2006. Both these countries are being dubbed as the worlds' largest International Islamic Financial Hubs (Qorchi, 2005). A comparative analysis between these two countries highlights the differences and similarities of the impact of monetary policy shocks on the Islamic banks' deposits. The analysis comprises of two major testing approaches. First, the auto-regressive distributed lag (ARDL) model is used to examine the long-run relationship among the variables. Second, the vector error-correction model (VECM) is adopted to explore the short-and long-run dynamics among the variables. Compared to the Malaysian Islamic banks' deposits, the study finds that the Islamic banks' deposits in Bahrain are sensitive to monetary policy changes. This implies that the Bahraini Islamic banks are less capable to offset the de-stabilizing impact of monetary policy as compared to its Malaysian counterpart.
... This condition is unlikely to prevail when commercial banks mark-up domestic interest rates over a foreign rate. Secondly, domestic financial markets (both money and capital markets) are underdeveloped and as a result monetary policy is not likely to transmit into immediate rapid changes in short-term and long-term interest rates (Ramlogan, 2004). ...
Purpose
The purpose of this paper is twofold. First, it estimates the sterilization coefficients for several Caribbean countries. Second, it contributes to the literature by providing a conceptual framework for understanding why regional economies with fully pegged exchange rate regimes have not allowed the money supply to be endogenous to capital flows. This paper notes that a high sterilization coefficient plus a de facto pegged exchange rate indicates the existence of dual nominal anchors.
Design/methodology/approach
The paper presents a simple theoretical model to explain this phenomenon. The model combines the liquidity preference of commercial banks with an augmented uncovered interest parity equation.
Findings
The econometric evidence presented shows that several Caribbean economies with fixed exchange rate regimes also possess high sterilization coefficients. Given open capital accounts in the various economies, the paper argues that this finding contravenes the money neutrality thesis, which holds that only one nominal anchor can prevail in the long term.
Originality/value
The model emphasizes that the interest rate formation and liquidity preference of oligopolistic commercial banks – the dominant financial institutions in a post‐liberalized setting – prevents counteracting capital movements when monetary policy changes above or along a threshold or bank mark‐up interest rate.
... Commercial banks play a pivotal role in financial intermediation and the monetary transmission mechanism in Caribbean economies (Ramlogan 2004). Providing a more global perspective, Stiglitz (1989) argued that the financial system in developing economies is likely to be dominated indefinitely by commercial banks. ...
This study explores how shocks in the foreign exchange market influence the allocation of commercial bank assets. A consistent pattern of asset allocation was discovered for Guyanese and Jamaican commercial banks. A positive one standard deviation shock (a surplus) in the foreign exchange market results in significantly greater investments in foreign assets relative to loans to the domestic private sector. The one standard deviation shock also results in a decrease in non-remunerated excess reserves; thus signalling that the excess cash are more likely to be invested into foreign assets rather than domestic currency loans when there is a surplus of foreign currencies. The same unit shock results in a foreign exchange rate depreciation in the contemporaneous time period. That the respective currencies depreciate when there is a surplus could indicate traders hoard the surplus initially for profit taking.
... monthly, 1991:9 - Recursive VAR (i) Following a unit shock to the reverse repo, the inflation rate decelerates within two months by approximately 0.1 percent per month. (ii) There are very strong, albeit temporary, real sector effects, as real economic activity declines by approximately 2.0 percent in four months. No confidence intervals reported. Ramlogan (2004) Quarterly data; Jamaica and Barbados: 1970: 1 to 1999:4 , Trinidad and Tobago: 1970:1 to 2000:2, Guyana: 1970:1 to 1998:4 Structural VAR (i) In each country except Barbados a shock to loans accounts for over 28 per cent of the variance in output over the long run. (ii) In Barbados although credit shocks are not as important as exchange ...
This paper surveys the evidence on the effectiveness of monetary transmission in developing countries. We summarize the arguments for expecting the bank lending channel to be the dominant means of monetary transmission in such countries, and present a simple model that suggests why this channel may be both weak and unreliable under the conditions that usually characterize those economies. Next, we review the empirical methodologies that have been employed in the recent literature to assess monetary policy effectiveness, both in developing countries as well as in industrial and emerging economies, essentially based on vector autoregressions (VARs). It is very hard to come away from this review of the evidence with much confidence in the strength of monetary transmission in developing countries. We distinguish between the 'facts on the ground' and 'methodological deficiencies' interpretations of the absence of evidence for strong monetary transmission. We suspect, however, that 'facts on the ground' are indeed an important part of the story. The fact that a wide range of empirical approaches have failed to yield evidence of effective monetary transmission in developing countries, and that the strongest evidence for effective monetary transmission has arisen for relatively prosperous and more institutionally-developed countries such as some central and Eastern European transition economies (at least in the later stages of their transition) and Tunisia, makes us doubt whether methodological shortcomings are the whole story. If this conjecture is correct, the stabilization challenge in developing countries is acute indeed, and identifying the means of enhancing the effectiveness of monetary policy in such countries is an important challenge.
... For exploring how the monetary shocks affect output and price level, we employ the VAR methodology based on Sims (1980), which has been increasingly employed in recent years in many studies (Dabla-Norris and Floerkemeir 2006, Ramlogan 2004, Morsink and Bayoumi 2001, Ahmed 2002). The chief advantage of using the standard VAR is that only minimal restrictions need to be imposed. ...
Fiji’s central bank, the Reserve Bank of Fiji (RBF) since its inception in 1983, has been pursuing monetary policy with the mandated objectives of economic growth with price stability and an adequate level of exchange reserves. In 1988, as part of financial sector reforms, RBF discontinued the use of direct instruments and switched on to employment of indirect instruments for influencing interest rates. For the past two decades, RBF has been conducting regular open market type operations in its own paper, known as RBF Notes for liquidity management. The yield to maturity of its 91-day RBF Notes determined through tender system, known as policy indicator rate (PIR) signals the monetary policy stance of RBF. This paper undertakes an empirical study of transmission mechanism of monetary policy over a 17–year period (1990Q1-2006Q4). Using variance decomposition and impulse response analysis, we find that money channel is the most important one amongst the four channels of transmission mechanism investigated.
Purpose
This paper investigates the impact of a monetary policy shock on the production of a sample of 312 industries in manufacturing, mining and utilities in the United States using a factor-augmented vector autoregression (FAVAR) model.
Design/methodology/approach
The authors use a FAVAR model that builds on Bernanke et al. (2005) and Boivin et al. (2009). The main assumption in this model is that the dynamics of a large set of macro variables are captured by some observed and unobserved common factors. The unobserved factors are extracted from a large set of macroeconomic data. The key advantage of using this model is that it allows extracting the impulse responses of a wide range of macroeconomic variables to structural shocks in the federal funds rate.
Findings
The results indicate that industries exhibit differential responses to an unanticipated monetary policy tightening. In general, manufacturing industries appear to be more sensitive compared to mining, and utility industries and durable manufacturing industries are found to be more sensitive than those within nondurable and other manufacturing industries to a monetary policy shock. While all industries respond to the policy shock, most of the responses are reversed between 12 and 22 months.
Research limitations/implications
The implication of our results is that monetary policy can be used to impact most US industries for four years and beyond. The existence of disparate responses across industries underscores the difficulty of implementing a monetary policy that will generate the same impact across industries. As the effects of the policy are distinct, policymakers may want to attend to the unique impacts and implement industry-specific policy.
Practical implications
The study is important in the context of the current challenges in the US economy caused by the spread of coronavirus. For example, to tackle the current pandemic, the researchers are trying to come up with cures for COVID-19. A considerable response of the chemical industry that provides materials to pharmaceutical and medicine manufacturing to the monetary policy shock implies that an expansionary monetary policy may facilitate an invention and adequate supply of the cure later on. The same policy may not effectively stimulate production in apparel or leather product industries that are being hard hit by the pandemic.
Originality/value
The study contributes to the literature in broadly two aspects. First, to the best of our knowledge, this is the first paper that investigates the impact of a monetary policy shock on a sample of 312 industries in manufacturing, mining and utilities in the US. Second, to identify structural shocks and investigate the effects of monetary policy shocks on economic activity, the authors diverge from the literature's traditional approach, i.e. the vector autoregression (VAR) method and use a FAVAR method. The FAVAR provides a comprehensive description of the impact of a monetary policy innovation on different industries.
The broad impact of the travel industry on economies has been comprehensively analysed in the tourism literature. Despite this, its consequences for monetary policy have remained unaddressed. This article aims at providing a first approach in this line for the case of three small tourist islands such as Cabo Verde, Mauritius and Seychelles. The research is based on a Bayesian estimation using a dynamic stochastic general equilibrium model (DSGE), and the optimal response to a tourism demand shock of four monetary policies is analysed. According to the results, both a conventional peg and an inflation-targeting policies achieve better economic performance. More precisely, the inflation is lower in the former. However, the rise in consumption and the gain in the external competitiveness are sharper in the latter. Finally, the other two policies, an inflation-targeting with managed exchange rate policy and an imported-inflation targeting policies, generate higher consumption and external competitiveness, but, also higher inflation and interest rate.
Purpose
The conventional and new inflation bias theories present two distinct facets to explain the outcome of excess inflation without output gains by a discretionary central banker. First is the temptation to achieve a higher than potential output, and, second is not to let it falter. The authors explicitly account for these two distinct dimensions in empirical formulations both exogenously and endogenously. Specifically, the purpose of this paper is to investigate what monetary discretion can and cannot do in terms of dual objectives – inflation and growth – across boom and bust cycles, both directly and indirectly.
Design/methodology/approach
(i) Segregate the economic activity into boom and bust cycles; (ii) Explicitly account for the two dimensions of conventional and new inflation bias theories; and (iii) model and estimate the direct and indirect effects of monetary discretion across business cycles.
Findings
The results indicate considerable asymmetries in the effects of monetary discretion and distribution thereof across objectives and cycles. The direct impact of monetary discretion tends to induce significantly higher inflation in boom and bust cycles, while it exerts a positive but insignificant effect on output. The inflation effects are more pronounced in boom than bust cycles and vice versa are the output effects. The indirect effects on output via inflation are significantly pernicious, which are more pronounced in expansions than recessions.
Originality/value
In a nutshell, instead of benefiting, monetary discretion tends to harm in terms of both the dual policy objectives, which cautions about its well calculated and constrained use only.
This study used Vector Auto regression (VAR) model to analyze effectiveness of monetary policy transmission mechanism in Indonesia through Inflation Expectation Channel period 1990:2-2007:1. That effectiveness was measured by two indicators, they are: (1) : (1) how fast or how many time lag needed since the shock of monetary instruments (rSBI) until the realisation of final target of monetary policy (inflation). (2) How strong the variables of inflation expectation line response the shock of SBI interest rate and other variable. This study used secondary data issued by Bank Indonesia and BPS as well as from International Finance Statistic (IFS). The result of the study shows that response velocity of variable in Inflation Expectation Channel towards shock instrument of monetary policy (rSBI) until reach the final target or time tag about 12 quarterly or twenty six months. While impulse response function of variables in this channel to the shock instrument of monetary policy (rSBI) is quiet weak and the main channel that is inflation expectation and exchange rate are not able to explain diversity final target of monetary policy (inflation) about 33,88%, while variable of inflation expectation only able to explain diversity of inflation about 15,03%. Meanwhile, we still able economically to conclude that mechanism of monetary policy transmission through Inflation Expectation Channel is effective to reach the final target of monetary policy of Indonesia period of 1990:2-2007:1
This paper examines the relative effectiveness of the use of indirect and direct monetary policy instruments in Barbados, Jamaica and Trinidad and Tobago, by estimating a restricted Vector Autoregressive model with Exogenous Variables (VARX). The study assumes that the central bank conducts monetary policy using a Taylor-type rule and it evaluates the effects of a reserve requirement policy. The results show that although a positive shock to the policy interest rate has a direct effect on commercial banks' interest rates, there is a weak transmission to the real variables. Furthermore, an increase in the required reserve ratio is successful in reducing private sector credit and excess reserves, while at the same time alleviating pressures on the exchange rate. The findings therefore indicate that central banks in small open economies should consider using reserve requirements as a complement to interest rate policy, to achieve their macroeconomic objectives.
This paper investigates the exchange rate channel of monetary policy transmission in Namibia
over the quarterly 1993:Q1 - 2011:Q4. The empirical analysis was conducted using innovation
accounting tools such as generalised impulse response functions and forecast error variance
decompositions obtained from a structural vector autoregressive model (SVAR). The results show
that the exchange rate channel is operational. That is, changes in the monetary policy
instruments affect the exchange rate variable which in turn transmits the shocks to output and
prices but weak and not so significant.
There is more consensus on the effects of monetary policy than its transmission mechanism. Two channels of transmission mechanisms are the conventional interest rate channel and the credit channel. I investigate the channels of monetary policy transmission in the U.S. using the factor-augmented vector autoregressive (FAVAR) models developed by Bernanke, Boivin & Eliasz (2005). The newly developed FAVAR approach allows the researcher to include all relevant macroeconomic variables in the model and analyze them. Therefore, the FAVAR models span a larger information set and generate better estimates of impulse response functions than the commonly used vector autoregressive (VAR) models that utilize only 4-8 variables. I include 154 monthly U.S. time series variables for the period 1970-2014. The findings support the existence of the credit channel in the U.S. The conclusion remains the same when the nonborrowed reserve operating regime (October 1979-October 1982) is removed from the sample period.
The objective of the study is to assess the importance of the bank lending channel in the transmission of monetary policy in Kenya. The lending view provides that a monetary tightening affects aggregate demand by shifting the loan supply schedule left. This reduction however may also be caused by depressed demand for loans through the conventional interest rate channel. To avoid this ambiguity, we test the lending channel using a vector error correction model in a frame work that allows the identification of the shifts of demand and supply schedules in the bank loan market. In this way the identification problem inherent in approaches based on aggregate data is explicitly addressed. Impulse responses are used to analyze the impact of a monetary policy shock on loan quantity, loan price and real output. The empirical evidence suggests the dominance of the bank lending channel in Kenya.
This paper surveys the evidence on the effectiveness of monetary transmission in low-income countries. It is hard to come away from this review with much confidence in the strength of monetary transmission in such countries. We distinguish between the "facts on the ground" and "methodological deficiencies" interpretations of the absence of evidence for strong monetary transmission. We suspect that "facts on the ground" are an important part of the story. If this conjecture is correct, the stabilization challenge in developing countries is acute indeed, and identifying the means of enhancing the effectiveness of monetary policy in such countries is an important challenge.
Since 2000 the Chinese economy has consistently maintained its rapid growth momentum. It has recently also experienced a high degree of volatility that is mainly due to overheating and shock absorbed from the 2008 global financial tsunami. In light of the economic instability derived from the financial tsunami, this article examines empirical evidence regarding the effectiveness of China's monetary policy to dampen the swing of economic cycles. Using the vector autoregression (VAR) model, it concludes that a traditional Keynesian interest-rate channel was China's major monetary transmission mechanism before the financial tsunami, but afterward it changed to an asset-price channel.
Abstract This paper uses the method of structural vector autoregressions to decompose movements of real output and prices into demand and supply innovations for four Caribbean economies: Barbados, Jamaica, Trinidad and Tobago, and Guyana. The aim of the analysis is to assess if these economies could feasibly form part of a Caribbean monetary union. Correlations between the demand and supply innovations are, however, typically low, indicating that monetary union may lead to greater stabilisation problems for these economies. Copyright 2010 Blackwell Publishing Ltd.
Purpose
– Using quarterly data for a sample of 17 industrial countries, the purpose of this paper is to study asymmetry in the face of monetary shocks compared to government spending shocks.
Design/methodology/approach
– The paper outlines demand and supply channels determining the asymmetric effects of monetary and fiscal policies. The time‐series model is presented and an analysis of the difference in the asymmetric effects of monetary and fiscal shocks within countries is presented. There then follows an investigation of the relevance of demand and supply conditions to the asymmetric effects of monetary and fiscal shocks. The implications of asymmetry are contrasted across countries.
Findings
– Fluctuations in real output growth, price inflation, wage inflation, and real wage growth vary with respect to anticipated and unanticipated shifts to the money supply, government spending, and the energy price. The asymmetric flexibility of prices appears a major factor in differentiating the expansionary and contractionary effects of fiscal and monetary shocks. Higher price inflation, relative to deflation, exacerbates output contraction, relative to expansion, in the face of monetary shocks. In contrast, larger price deflation, relative to inflation, moderates output contraction, relative to expansion in the face of government spending shocks. The growth of output and the real wage decreases, on average, in the face of monetary variability in many countries. Moreover, the growth of real output and the real wage increases, on average, in the face of government spending variability in many countries. Asymmetry differentiates the effects of monetary and government spending shocks within and across countries. The degree and direction of asymmetry provide a new dimension to differentiate between monetary and fiscal tools in the design of stabilization policies.
Originality/value
– The paper's evidence sheds light on the validity of theoretical models explaining asymmetry in the effects of demand‐side stabilization policies. Moreover, the evidence should alert policy makers to the need to relax structural and institutional constraints to maximize the benefits of stabilization policies and minimize the adverse effects on economic variables.
Purpose
The purpose of this paper is to extend the literature on the relationship between inflation and inflation uncertainty by examining three Caribbean countries: the Bahamas, Barbados, and Jamaica.
Design/methodology/approach
ARMA‐GARCH models are used to estimate inflation uncertainty along with Granger‐causality tests to infer the relationship between inflation and inflation uncertainty.
Findings
The results reveal that both the Bahamas and Jamaica exhibit a high degree of volatility persistence in response to inflationary shocks, while Barbados has a much lower persistence measure. Granger‐causality tests indicate that an increase in inflation has been a positive impact on inflation uncertainty for each country. However, an increase in inflation uncertainty yields a decrease in inflation in the case of Jamaica. In summary, the results for the Bahamas and Barbados support the Friedman‐Ball hypothesis, whereas the results for Jamaica support Holland's stabilization‐motive hypothesis.
Research limitations/implications
Future research on inflation and inflation uncertainty can be extended to incorporate possible regime shifts associated with fiscal and monetary policy.
Originality/value
The study fills a void in the literature with respect to the inflation‐inflation uncertainty nexus for Caribbean countries. The results of the paper may be useful to policymakers in the formulation of fiscal and monetary policy.
Existing theory and evidence on the effects of monetary policy are reviewed. Substantial room for disagreement among economists remains. New evidence, based on multivariate time series studies of several countries, is presented. While certain patterns in the data consistent with effective monetary policy are strikingly similar across countries, others, particularly the tendency of interest rate increases to predict high inflation, are harder to reconcile with effective monetary policy.
This paper assesses the impact of a monetary policy shock on the U.S. economy. The authors' measures of contractionary monetary policy shocks are associated with a fall in various monetary aggregates and a rise in the federal funds rate, declines in different measures of real activity, and sharp declines in commodity prices and a delayed decline in the GDP price deflator. In addition, net funds raised by the business sector increases for roughly a year, after which it falls. Finally, the authors find that households do not adjust their financial assets and liabilities for several quarters after a monetary shock. Copyright 1996 by MIT Press.
We analyze the response of small versus large manufacturing firms to monetary policy. The goal is to obtain evidence on the
importance of financial propagation mechanisms for aggregate activity. We find that small firms account for a significantly
disproportionate share of the manufacturing decline that follows tightening of monetary policy. They play a surprisingly prominent
role in the slowdown of inventory demand. Large firms initially borrow to accumulate inventories. After a brief period, small
firms quickly shed inventories. We attempt to sort financial from nonfinancial explanations with evidence on asymmetries and
on balance sheet effects on inventory demand across size classes.
There has been extensive empirical research on the role of credit markets in the transmission of US monetary policy, but the evidence for other countries is scarce. This paper compares the US experience with a set of 13 European countries by examining monetary VARs including banks' balance sheets in the spirit of Bernanke and Blinder (1992). It is shown that the VAR methodology provides plausible results for interpreting interest rate shocks as monetary policy shocks in most countries. The evolution of bank lending after a monetary contraction is then analysed. For most countries, it is shown that bank loans decline more than money in the medium run. In the short run, however, loans are sticky and react less than money. Also, loans and output responses to an increase in interest rate tend to be more synchronized than those of money and output. This evidence is similar to the US and is consistent with the broad credit channel of monetary policy.
This paper compares different nominal anchors in the case of a fixed exchange rate regime for the future single regional currency of the Economic Community of the West African States (ECOWAS). We study the anchor choice when the countries focus the exchange rate policy to promote internal and external competitiveness. We consider four foreign anchor currencies: the us dollar, the euro, the yen and the yuan. Using a counterfactual analysis, we find little support for a dominant peg in the ECOWAS zone. In attempting to select an anchor currency, as regards internal and external competitiveness, several aspects need to be taken into consideration: the variability of the commodity prices, adverse downward trend movements, the stability of export revenues and the invoicing currency. A discriminating element is the direction toward which the anchor currency moves, while the world price of commodities evolves in the opposite direction. Our simulations show that the countries would not agree on the same anchor if they pursue several goals: maximizing the export revenues, minimizing their variability, stabilizing them and minimizing the real exchange rate misalignments from its fundamental value.
Kashyap, Nelson Mark, Alan Viard and the participants at the conference for comments and suggestions. I am grateful to the National Science Foundation and the Federal Reserve Traditional studies of monetary policy's impact on the real economy have focused on its aggregate e®ects. Beginning with Friedman and Schwartz (1963), modern empirical research in monetary economics emphasizes the ability of policy to stabilize the macroeconomy. But causal observation suggests that business cycles have distributional
This paper tests the present readiness of Slovakia to join the European Monetary Union (EMU) based on the classical Optimum Currency Area criteria, the degree of trade intensity and business cycle synchronization. The results do not fully confirm the hypothesis that Slovakia already constitutes an optimum monetary union with the rest of the EMU countries mainly the labour mobility is largely ineffective as adjustment mechanism. But, Slovakia is a open economy, its degree of trade integration is the highest among the Central and Eastern European countries and its economic and production structures are quite similar to the intra-EMU average. Moreover, Slovakia's business cycle appears at least as highly synchronized with the EMU''s one as some present, small and peripheral EMU member countries. This would indicate that this country is equally a suitable candidate for the EMU membership and that the Euro adoption should not increase the likelihood of asymmetric shocks.
Using data for the U.S. manufacturing sector, we test for the existence of a broad credit channel for monetary policy, which operates through the total supply of loans. Our test focuses on the relationship between internal funds and business investment. After a monetary tightening, we find that this relationship becomes much closer for small firms but not for large firms. In contrast, after a monetary easing, the relationship is little changed for all firms. This evidence supports the existence of a broad credit channel.
This paper uses vector autoregressions to examine the monetary transmission mechanism in Japan. The empirical results indicate that both monetary policy and banks' balance sheets are important sources of shocks, that banks play a crucial role in transmitting monetary shocks to economic activity, that corporations and households have not been able to substitute borrowing from other sources for a shortfall in bank borrowing, and that business investment is especially sensitive to monetary shocks. We conclude that policy measures to strengthen banks are probably a prerequisite to restoring the effectiveness of the monetary transmission mechanism.
Existing strategies for econometric analysis related to macroeconomics are subject to a number of serious objections, some recently formulated, some old. These objections are summarized in this paper, and it is argued that taken together they make it unlikely that macroeconomic models are in fact over identified, as the existing statistical theory usually assumes. The implications of this conclusion are explored, and an example of econometric work in a non-standard style, taking account of the objections to the standard style, is presented.
Using a vector autoregression (VAR) approach, this study re-examines several hypotheses suggested by the economic literature on the economics of FDI applying quarterly time series data from China, a country which has recently become the second largest host country for FDI. Innovation accounting (variance decomposition and impulse response function analysis) is applied to analyse the various interrelationships between FDI and other economic variables of interest in a VAR system. The empirical research using this method in the case of China is limited, the study therefore provides an interesting advance in the literature on the economics of FDI in China.
We consider a nonstationary vector autoregressive process which is integrated of order 1, and generated by i.i.d. Gaussian errors. We then derive the maximum likelihood estimator of the space of cointegration vectors and the likelihood ratio test of the hypothesis that it has a given number of dimensions. Further we test linear hypotheses about the cointegration vectors.The asymptotic distribution of these test statistics are found and the first is described by a natural multivariate version of the usual test for unit root in an autoregressive process, and the other is a χ2 test.
This paper studies the sources of economic fluctuations and their implications for exchange rate regime choice in key Latin American countries. In general, external shocks play a limited role in driving output fluctuations in these countries; this absence of common business cycles undermines the case for fixed exchange rates. On the other hand, although there is some evidence that real exchange rates depreciate in response to adverse external shocks, this depreciation, in turn, tends to contract output in the short run. This suggests that exchange rate rigidity may not be as costly for these economies as conventional economic theory predicts.
In this paper, we modify the method of Blanchard and Quah [American Economic Review 79 (1989) 655] in order to estimate a structural VAR model appropriate for a small open economy. In this way, we identify shocks to output and prices in the members of the two monetary unions that make up the African CFA Franc Zone. The costs of monetary union membership will depend on the extent to which price and output shocks are correlated across countries and the degree of similarity in the long-run effects of the shocks on the macroeconomy. The policy conclusions depend on the relative importance of different macroeconomic variables to policymakers and the speed with which a policymaker is able to respond to a shock.
This paper empirically tests the importance of the credit channel in the transmission of monetary policy. Three credit variables are analyzed: total bank loans, bank holdings of securities relative to loans, and the difference in the growth rate of short-term debt of small and large firms. In order to determine the marginal effect of the credit channel over the standard money channel, the significance of the credit variables is studied in a model that includes money (M2). In most cases, the credit variables play an insignificant role in the impact of monetary policy shocks on output.
Using the Bernanke's contemporaneous structural VAR, this paper investigates the role of money and credit in the monetary transmission mechanism during the pre- and post-liberalization periods in Malaysia. During the pre-liberalization period where credit and interest rates were regulated, the evidence supports the dominance of bank credit shocks over money shocks in explaining the output variability. After the liberalization of financial market, however, money as well as credit innovations were proven to make significant contribution to the output fluctuation.
The paper investigates the role of bank lending in the monetary transmission process in the Netherlands. The Johansen approach is used to identify supply and demand relationships in the credit market, and it is concluded from the short-run dynamics that this market is demand-determined. In this way, an important identification problem of studies based on aggregate data is explicitly addressed. Results are consistent with earlier fundings that banks hold a buffer stock of securities which they use to offset monetary shocks. The main implication of the study is that a bank lending channel is not an important monetary transmission mechanism.
The authors investigate the impact of 'credit shocks' on real activity by using changes in reserve requirements to measure shocks to financial intermediation. Reserve requirement changes are often made for bank regulatory reasons and, hence, are far more exogenous with respect to macroeconomic developments than the credit variables used in earlier tests. The authors present reduced-form evidence that, even after controlling for the link between monetary aggregates and real activity, an increase in reserve requirements lowers aggregate investment, real GNP, and commercial and industrial lending by banks. Copyright 1995 by Ohio State University Press.
This paper investigates the transmission of Israeli monetary policy since 1990. Two issues are addressed: the extent to which monetary policy exerts real effects, and the relative importance of different transmission channels. The impact of monetary restraints on aggregate industrial production is found to be small, although industrial sectors open to trade appear to suffer to a larger extent than closed sectors. Three transmission channels are analyzed by comparing the empirical evidence to that predicted by theory. While the credit and exchange rate channels may be important mechanisms of transmission, the interest rate channel finds weak support in the data.
In many developing countries the financial system is characterized by the absence of organized markets for securities and equities, by capital controls, and by legal ceilings on bank borrowing and lending rates, a situation which gives rise to parallel markets for foreign exchange and informal loan markets. This paper analyzes how changes in monetary policy instruments (bank credit, administered interest rates, required reserve ratios, and intervention in the parallel exchange market) are transmitted to domestic aggregate demand in a financially-repressed economy. Such an analysis is necessary to understand how the move to a more market-oriented system would affect the economy in the short run.
In this paper, the authors use the relative moments in bank loans and commercial paper to provide evidence on the existe nce of a loan-supply channel of monetary-policy transmission. The author s find that tighter monetary policy leads to a shift in firms' mix of external financing: commercial paper issuance rises while bank loans fall. This suggests that contractionary policy can indeed reduce lo an supply. Furthermore, such shifts in loan supply seem to affect investment, even controlling for interest rates and output. Copyright 1993 by American Economic Association.
The authors show that the interest rate on Federal funds is extremely informative about future movements of real macroeconomic variables. Then they argue that the reason for this forecasting success is that the funds rate sensitively records shocks to the supply of bank reserves; that is, the funds rate is a good indicator of monetary policy actions. Finally, using innovations to the funds rate as a measure of changes in policy, the authors present evidence consistent with the view that monetary policy works at least in part through "credit" (i.e., bank loans) as well as through "money" (i.e., bank deposits). Copyright 1992 by American Economic Association.
This paper calculates indices of central bank autonomy (CBA) for 163 central banks as of end-2003, and comparable indices for a subgroup of 68 central banks as of the end of the 1980s. The results confirm strong improvements in both economic and political CBA over the past couple of decades, although more progress is needed to boost political autonomy of the central banks in emerging market and developing countries. Our analysis confirms that greater CBA has on average helped to maintain low inflation levels. The paper identifies four broad principles of CBA that have been shared by the majority of countries. Significant differences exist in the area of banking supervision where many central banks have retained a key role. Finally, we discuss the sequencing of reforms to separate the conduct of monetary and fiscal policies. IMF Staff Papers (2009) 56, 263–296. doi:10.1057/imfsp.2008.25; published online 23 September 2008
This paper examines how recent econometric policy evaluation research on monetary policy rules can be applied in a practical policymaking environment. According to this research, good policy rules typically call for changes in the federal funds rate in response to changes in the price level or changes in real income. An objective of the paper is to preserve the concept of such a policy rule in a policy environment where it is practically impossible to follow mechanically any particular algebraic formula that describes the policy rule. The discussion centers around a hypothetical but representative policy rule much like that advocated in recent research. This rule closely approximates Federal Reserve policy during the past several years. Two case studies—German unification and the 1990 oil-price shock—that had a bearing on the operation of monetary policy in recent years are used to illustrate how such a policy rule might work in practice.
Standard explanations of the bivariate correlation of money and income attribute this correlation to an inability of agents to discriminate in the short run between real and nominal sources of price shocks. This paper is an empirical comparison of the standard explanation with two alternatives: 1) the"credit view", which focuses on financial market imperfections rather than real-nominal confusion; and 2) the real business cycle approach, which argues that the money-income correlation reflects a passive response of money to income. The methodology, which is a variant of the Sims VAR approach, follows Blanchard and Watson (1984) in using an estimated, explicitly structural model to orthogonalize the VAR residuals. (This variant methodology, I argue, is the more appropriate for structural hypothesis testing.) The results suggest that the standard explanations of the money-income relation are largely, but perhaps not completely, displaced by the alternatives.
The question of how monetary policy affects the real economy is a perennial one in macroeconomics. Over the past several decades, however, the focus of the debate has changes. Today it is taken for granted that monetary policy affects aggregate demand; what is debated is why prices do not adjust fully to compensate for shifts in demand. Thirty years ago, in contrast, sluggish price adjustment was taken for granted; what was debated was the magnitude of the effect of monetary policy on aggregate demand and the channels through which that effect occurred. This paper returns to the subject of that older literature. A fresh look at the way monetary policy affects aggregate demand is particularly timely in light of recent developments in theoretical analyses of credit markets. Work over the past 15 years has suggested that imperfections are a central feature of capital markets, and that these imperfections can cause credit allocation to be made largely on the basis of quantity rationing rather than price adjustment and can create a special role for lending by financial intermediaries. This work has also shown that credit market imperfections can have important consequences for macroeconomic fluctuations in general and for the way monetary policy is transmitted to aggregate demand in particular.
This paper provides an overview of the monetary transmission mechanism describing the impact of changes in monetary policy on real GDP. Changes in financial market prices--including long-term interest rates and exchange rates--are the main vehicle for the transmission of policy. The framework incorporates rational expectations and policy rules. It is empirical and appears to fit the facts well. Copyright 1995 by American Economic Association.