Abstract

This study analyses the implications of Jeffery–Lindley’s paradox and Global Financial Crisis (GFC) for the operational aspect of macroeconomic policy coordination for financial stability. Using a Bayesian Vector Auto-regressive model and data from Jan 1985 to June 2016, our key findings suggest that the claim of macroeconomic policy interaction, interdependence and significance of coordinated policy operations for the financial stability holds its ground. The argument in the support for policy coordination for financial stability was found to be robust against the Jeffreys–Lindley’s paradox and in the Post-GFC era. A profound practical, operational and philosophical implication of this study is the positive aspects of Jeffreys–Lindley’s paradox and the possibility of employing the Frequentist and Bayesian estimation techniques as complementing rather competing frameworks.

Highlights

  • Economic policies have profound operational implications and are important tools for any government to achieve its socio-economic objectives and financial obligations

  • The first research questions the subject study focusing on is how the monetary and fiscal policy impact the financial markets? Secondly, the study investigates whether there is interaction between monetary and fiscal policies and if the notion of policy coordination for financial stability holds in a Bayesian Framework? The third research question we focus on is whether the impact macroeconomic policies on the financial sector is still significant in the post Global Financial Crisis (GFC) period

  • This study considers the symmetry of stock and bond market response to macroeconomic policy operations; the logical reason for this is that when the economic policy

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Summary

Introduction

Economic policies have profound operational implications and are important tools for any government to achieve its socio-economic objectives and financial obligations. The operational question which arises and provides the rationale for this study is ‘what are the limitations associated with relying on a particular analytical framework, especially when it comes to influencing the financial sector?’ The Bayesian (based on Bayes’ theorem) is stochastic whereas the Frequentist (based on Gauss-Markov theorem) is rather a deterministic approach. These differences in empirical approaches may have profound operational implications as they may show different impacts of macroeconomic policies. It provides the rationale to this study by posing the questions that how financial markets behaviour to fiscal and monetary policy operations might have changed due to the GFC? Concomitantly, it makes a case to revisit the aspect of policy coordination for financial stability in the Post-GFC world as we have ample evidence to support the shift in the response of the stock market to monetary policy alone, which is one reason of this endeavour

Empirical framework
Bayesian estimation and Bayes theorem
Prior’s selection
Analysis and findings
Financial markets and policy interaction in Bayesian VAR
Policy interaction post-global financial crisis
Findings
Conclusions and policy implications
Full Text
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