Abstract
Whether inflation and output respond symmetrically or asymmetrically to the same size of contractionary and expansionary monetary policy shock has important policy implications. This paper shows the presence of asymmetric responses in Armenian inflation and output to positive and negative monetary policy shocks of the same size by employing econometric models. Contractionary policy decreases inflation less than expansionary policy increases it. Output reacts in the opposite way. An estimated small open economy DSGE model with sticky wages and investment adjustment costs explains about half of the asymmetry observed in the monetary policy transmission mechanism. This paper finds that the main part of inflation reaction asymmetry is a result of a highly convex Phillips curve for the importers. The nonlinearities of the internal economy explain the predominant part of the asymmetry in output reaction.
Highlights
Do positive and negative interest rate shocks of the same size have asymmetric effects on inflation and output? This is a relevant question from a monetary policy perspective
Shocks The model is driven by fifteen structural shocks: consumption preference, labour supply, marginal efficiency of investments (Ψt), government spending (Gt), risk premium (Ωt), stationary productivity (Zt), mark-up on domestically produced goods, mark-up on imported consumption goods, mark-up on imported investment goods, mark-up on imported goods used in the export sector, mark-up on exported goods, monetary policy, foreign demand (Yt*), foreign inflation, and foreign interest rates (Rt*)
This paper empirically shows the presence of asymmetries in the monetary policy transmission mechanism in Armenia
Summary
Do positive and negative interest rate shocks of the same size have asymmetric effects on inflation and output? This is a relevant question from a monetary policy perspective. Impulse response analysis shows the presence of significant asymmetric reactions in the variables to positive and negative monetary policy shocks of the same size. Such empirical models do not explain the sources of the asymmetries. The paper estimates the contribution of specific frictions or model blocks in the creation of asymmetry in the monetary policy transmission mechanism. When the economy is in a demand-driven expansion, an increase of contractionary monetary policy shock accelerates the decline in output but decreases the relative response of inflation.
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