The Effects of Financial Shocks on Macroeconomic Variables and Monetary Policy in Emerging Market Economies

Abstract

In this study, the effects of financial shocks on macroeconomic variables and monetary policy in small open emerging market economies are analyzed both theoretically and empirically. Clarida et al. (1999) model was developed by adding financial stability as suggested by Tunay and Tunay (2019). Then, the macroeconomic effects of financial shocks and the reaction of the central bank to it were analyzed empirically. Using data set collected from Brazil, China, India, Russia, South Africa and Turkey, a structural panel VAR model was estimated. The findings show that the financial shock caused significant and permanent fluctuations in the output gap, inflation and interest rate. In addition, it has been observed that the inclusion of financial stability in the central bank's objective function causes asymmetric effects on the output gap and inflation, and deepens the bank's political trade-off.