Remittances, Monetary Policy, and Partial Sterilization

Abstract

Remittances play a large and important role in certain economies, where they became a significant share of GDP. Official government records of these flows have been systematically improved since governments realized their importance, but a significant percentage of remittances remain unrecorded. This, together with the shadow economy, may pose a problem for monetary policy. This article uses a limited participation model to examine the differential effect that higher shares of remittances can have on monetary policy and describes the impact of remittances on a small open economy under partial sterilization. It demonstrates how a typical monetary shock will lead to a more pronounced liquidity effect when remittances become a higher proportion of GDP. It also shows that a positive remittance shock improves consumption and lowers interest rates, but as it also reduces work effort it momentarily lowers output. Such dynamics are exacerbated as the degree of partial sterilization is accentuated.