Domestic Monetary Policy Research Articles

Sectoral inflationary dynamics: cross-country evidence on the open-economy New Keynesian Phillips Curve

This paper empirically evaluates the significance of domestic and external factors on two-digit sectoral inflation dynamics in a sample of OECD countries using open-economy New Keynesian Phillips Curve models. It focuses on the independent impacts of imported consumption goods and intermediate inputs on sectoral inflation dynamics to investigate whether there is a systematic relationship between the extent of production integration and estimated sensitivities. The study begins with a formal analysis to show in which channels consumption goods and intermediate inputs affect inflation in the open-economy NKPC models. Then it employs the Prais-Winsten regression heteroskedastic panels corrected standard errors (PCSE) approach, rather than the GMM, to overcome various covariation issues in the empirical analysis. The results suggest that both domestic and external factors play significant roles in inflation dynamics. Impacts vary across sectors depending on the degree of integration into the global value chains and the nature of trade matters in detecting the appropriate trade effects on inflation. These results are of interest to policymakers since the heterogeneity in price-setting behavior among sectors complicates the monetary policy transmission mechanism. The finding that inflation dynamics is jointly determined by domestic and external factors necessitates coordination of domestic monetary policy and trade, as well as industrial policies. Trade and industrial policies need to be sector-specific and designed to improve competition in domestic and international markets to enhance the effectiveness of monetary policies.

International Bank Lending Channel of Monetary Policy

How does domestic monetary policy in systemic countries spillover to the rest of the world? This paper examines the transmission channel of domestic monetary policy in the cross-border context. We use exogenous shocks to monetary policy in systemically important economies, including the U.S., and local projections to estimate the dynamic effect of monetary policy shocks on bilateral cross-border bank lending. We find robust evidence that an increase in funding costs following an exogenous monetary tightening leads to a statistically and economically significant decline in cross-border bank lending. The effect is weakened during periods of high uncertainty. In contrast, the effect is found to not vary according to the degree of borrower country riskiness, further weakening support for the international portfolio rebalancing channel.

International Bank Lending Channel of Monetary Policy

How does domestic monetary policy in systemic countries spillover to the rest of the world? This paper examines the transmission channel of domestic monetary policy in the cross-border context. We use exogenous shocks to monetary policy in systemically important economies, including the U.S., and local projections to estimate the dynamic effect of monetary policy shocks on bilateral cross-border bank lending. We find robust evidence that an increase in funding costs following an exogenous monetary tightening leads to a statistically and economically significant decline in cross-border bank lending. The effect is weakened during periods of high uncertainty. In contrast, the effect is found to not vary according to the degree of borrower country riskiness, further weakening support for the international portfolio rebalancing channel.

Macrofinancial Linkages and Growth at Risk in the Dominican Republic

This paper uses the Growth-at-Risk (GaR) methodology to examine how macrofinancial conditions affect the growth outlook and its probability distribution. Using this approach, we evaluate risks to GDP growth in the Dominican Republic using quarterly data for 1996-2018. We group macrofinancial conditions in five principal determinants, based on 32 indicators. The Dominican Republic's growth distribution appears most vulnerable to negative shocks to domestic financial conditions, domestic leverage, domestic demand, and external demand, with additional repercussions from the external cost of borrowing in the longer run. Our findings show that domestic monetary policy plays a particularly important role in reducing growth vulnerabilities when the economy is weak.

Cross-Border Bank Flows and Monetary Policy

We analyze the impact of monetary policy on bilateral cross-border bank flows using the BIS Locational Banking Statistics between 1995 and 2014. We find that monetary policy in the source countries is an important determinant of cross-border bank flows. In addition, we find evidence in favor of a cross-border bank portfolio channel. As relatively tighter monetary conditions in source countries erode the net worth and collateral values of domestic borrowers, banks reallocate their claims toward safer foreign counterparties. The cross-border reallocation of credit is more pronounced for banks in source countries with weaker financial sectors, which are likely to be more risk averse. Lastly, the reallocation is directed toward borrowers in safer countries, such as advanced economies or economies with an investment grade sovereign rating. By highlighting the effect of domestic monetary policy on foreign credit, this study enhances our understanding of the monetary policy transmission mechanism through global banks.

Monetary policy co-movement and spillover of shocks among BRICS economies

ABSTRACTThe 2008 global financial crisis has revealed the possibility of cross-border spillover effects of domestic Monetary Policy (MP) on financial stability and capital flows around the world. Recognizing these facts, Central Banks in Advanced Economies (AE) have undertaken simultaneous Monetary Policy actions to minimize collateral damage and contain financial risks. In this paper, we investigate whether a similar spillover and co-movement of Monetary Policy exist among BRICS countries. Specifically, we study the transmission of monetary policy shocks among the member countries using monthly data. We use the method of Principal Component Analysis (PCA) and Vector Autoregression Model to identify possible dynamic relationships. Our results indicate possible co-movement in interest rates and significant cross-border transmission of monetary policy shocks among the BRICS countries.

The Effects of Influencing Macroeconomic Variables on Monetary Policy Shocks: The Case of Korea

Uncertainty about the international financial market has increased during the global financial crisis in 2008. As a result, financial market and real economic variables of developed and emerging economies became more sensitive to changes in the international financial market than controls set by their own respective monetary policies. In particular, in the case of small open economies such as Korea, the development of monetary policy has given priority to foreign factors such as exchange rate and capital outflow rather than domestic economic policy targets such as inflation and economic growth. This has led to a decline in independence in the determination of interest rate levels. This paper analyzed how foreign structural shocks affect domestic macroeconomic variables. We also analyzed how domestic monetary policy changes affected domestic macroeconomic variables before and after the global financial crisis. In this study, the period was divided into the period before the global financial crisis (2000:01-2009:06) and after the global financial crisis (2009:07-2018:05). Block exogeneity structural VAR model was used for analysis. According to the results, each macroeconomic variables’ response to monetary policy has been counterbalanced or weakened by the global financial crisis. Thus, there has been structural change in the channel mechanism of monetary policy.

Asset market responses to conventional and unconventional monetary policy shocks in the United States

Abstract We quantify the responses of a wide range of United States financial market variables to domestic monetary policy shocks over conventional and unconventional monetary policy environments. Our results show that responses to policy shocks are in the same direction but generally larger and more significant in the unconventional period. The larger responses are mostly due to larger shocks in the unconventional period, but some variables show evidence of a larger transmission of shocks. We separately use our framework to test shadow short rate estimates as a proxy for short-maturity interest rates across conventional and unconventional periods.

International monetary policy transmission through banks in small open economies

This paper studies the international transmission of monetary policy through banks in small open economies using the examples of Switzerland and Canada. We assess the inward transmission of foreign monetary policy for Switzerland and the outward transmission of domestic monetary policy for Canada. In both country cases, we focus on the international bank lending and the international portfolio channel, which make opposing predictions about how monetary policy transmits internationally through banks. Our results on the inward transmission of foreign monetary policy through banks in Switzerland are consistent with a role for the international portfolio channel, but we find no evidence for the traditional international bank lending channel. The results on the outward transmission of domestic monetary policy in Canada suggest that foreign lending by Canadian banks is affected through both channels, which work as predicted and largely balance each other.

The shocks matter: Improving our estimates of exchange rate pass-through

A major challenge for monetary policy is predicting how exchange rate movements will impact inflation. We propose a new focus: directly incorporating the underlying shocks that cause exchange rate fluctuations when evaluating how these fluctuations “pass through” to import and consumer prices. A standard open-economy model shows that the relationship between exchange rates and prices depends on the shocks which cause the exchange rate to move. We build on this to develop a structural Vector Autoregression (SVAR) framework for a small open economy and apply it to the UK. We show that prices respond differently to exchange rate movements based on what caused the movements. For example, exchange rate pass-through is low in response to domestic demand shocks and relatively high in response to domestic monetary policy shocks. This framework can improve our ability to estimate how pass-through can change over short periods of time. For example, it can explain why sterling's post-crisis depreciation caused a sharper increase in prices than expected, while the effect of sterling's 2013–15 appreciation was more muted. We also apply this framework to forecast the extent of pass-through from sterling's sharp depreciation corresponding to the UK's vote to leave the European Union.

A Comparison Analysis of Monetary Policy Effect Under an Open Economy Model

The paper analyzes and compares the effects of domestic monetary policy using DSGE, DSGE-VAR, and VAR based on a two-country open economy model of Korea and the U.S. According to impulse response analysis, a domestic interest rate hike raises won value in the case of DSGE and DSGE-VAR models, while in the case of the unrestricted VAR model, it lowers won value. In the marginal data density standard, DSGE-VAR (μ=1) is superior to DSGE or Bayesian VAR over the sample period. Conversely, in the in-sample RMSE criterion, especially for the won/dollar exchange rate, VARs are superior to DSGE or DSGE-VAR. It is necessary to study further if these differences are caused by model misspecification or omitted variable bias.

A Comparison Analysis of Monetary Policy Effect Under an Open Economy Model

The paper analyzes and compares the effects of domestic monetary policy using DSGE, DSGE-VAR, and VAR based on a two-country open economy model of Korea and the U.S. According to impulse response analysis, a domestic interest rate hike raises won value in the case of DSGE and DSGE-VAR models, while in the case of the unrestricted VAR model, it lowers won value. In the marginal data density standard, DSGE-VAR (μ=1) is superior to DSGE or Bayesian VAR over the sample period. Conversely, in the in-sample RMSE criterion, especially for the won/dollar exchange rate, VARs are superior to DSGE or DSGE-VAR. It is necessary to study further if these differences are caused by model misspecification or omitted variable bias.

Do Monetary Policy Announcements Affect Exchange Rate Returns and Volatility of Returns? Some Evidence from High‐Frequency Intra‐Day South African Data

AbstractThis paper examines the temporal effect of domestic monetary policy surprises on both returns and volatility of returns of the South African rand/U.S. dollar exchange rate. The analysis in this “event study” proceeds using intra‐day minute‐by‐minute exchange rate data, repo rate data from the South African Reserve Bank's scheduled monetary policy announcements, and market consensus repo rate forecasts. A carefully selected sample over the period August 2003 to November 2017 ensures that the change in monetary policy is exogenous to the exchange rate. We find statistically and economically significant responses in intra‐day high‐frequency South African rand/U.S. dollar exchange rate returns and volatility of exchange rate returns to domestic interest rate surprises, but anticipated changes have no bearing on exchange rate returns and their volatility. The empirical results also indicate that there is an instantaneous response of the rand/dollar exchange rate to monetary policy surprises and that monetary policy news is an important determinant of the exchange rate until at least 42 minutes after the pronouncement – suggesting a high degree of market “efficiency” in its mechanical sense (although not necessarily in the deeper economic‐informational sense) in processing this information. Essentially, the asymmetric GARCH results exhibit no leverage effects – positive and negative information shocks have symmetric effects on conditional variance.

Financial Globalization and Bank Lending: The Limits of Domestic Monetary Policy?

We empirically analyze how bank lending reacts to monetary policy in the presence of global financial flows. Employing a unique and novel dataset of the funding modes and currency composition of the full population of Norwegian banks in structurally identified regressions, we show that the efficiency of the bank lending channel is affected when banks can shift to international funding and thus insulate their costs of funding from domestic monetary policy. We isolate the effect of global factors from domestic monetary policy by focusing on the deviation of exchange rates from the prediction of (uncovered and covered) interest rate parity. The Norwegian banking sector represents an ideal laboratory since the exogenous exchange rate dynamics allows for a convincing identification of the relation between lending and global factors.

Thai inflation dynamics in a globalized economy

ABSTRACTThis paper investigates whether changes in Thai inflation dynamics during recent decades can be attributed to the process of globalization. The empirical analysis is based on a dynamic factor model and an unobserved components model that is consistent with an Open Economy New Keynesian Phillips curve. The findings suggest that in the short-run, Thai inflation has become increasingly sensitive to global factors since 2001, while becoming less reliant on domestic ones. During 2001–2007, the importance of this global factor can be attributed to a global output gap, while in the period thereafter, it only corresponds to world oil price movements. While global factors are important, Thai inflation is still heavily influenced by domestic monetary policy in the long-run. The implementation of an inflation targeting framework in May 2000 by the Bank of Thailand has led to improved inflation behavior through better anchored long-term inflation expectations.

Supply-side economics and the 2017 Tax Act

Abstract. Abstract. Several of the designers of the 2017 Tax Act were prominent as ‘supply side‛ advocates at the time of Reagan tax cuts during the 1980s. The economic argument for supply side tax rate reductions drew on a policy mix framework developed by Robert Mundell as early as 1962. Within that framework, the easy fiscal/ tight monetary policy solution was intended for circumstances of either pressure on reserves or the exchange rate (as during the Kennedy Administration) or of serious domestic inflation (as under the Carter and Reagan Administrations). Tax cuts in the US since the 1980s have not had the intended stimulus effects because neither the currency weakness nor inflationary preconditions have existed. Absent such conditions, tax rate reductions will generate either domestic over-heating or a redistribution of income to those in higher brackets. Any argument in favor of the 2017 Tax Act should not fall back on Mundell’s policy mix advocacy. In contrast, the case for an easy fiscal/ tight money policy may have unexpected force in situations of fixed exchange rates, or where domestic monetary policy options are otherwise constrained or absent – as in Eurozone periphery countries. Keywords. Supply side economics, Robert Mundell, Policy Mix classifications, 2017 Tax Act, Eurozone macroeconomics. JEL. B30, E30, E50, E60, F20.

Monetary Policy Spillovers Through Invoicing Currencies

This paper explores the role of trade invoicing currencies in the international spillover of monetary policy. Using high-frequency measures of Federal Reserve monetary policy shocks, I show the exchange rates, interest rates and equity returns in countries with larger shares of dollar-invoiced imports systematically respond more to US monetary policy. I document similar transmission effects from ECB monetary policy shocks to countries with euro-invoiced imports. I rationalize these findings within a New Keynesian framework. As a result of these spillover effects, countries where traded goods are should be less effective at implementing domestic monetary policy.

Financial Globalization and Bank Lending: The Limits of Domestic Monetary Policy?

We empirically analyze how bank lending reacts to monetary policy in the presence of global financial flows. Employing a unique and novel dataset of the funding modes and currency composition of the full population of Norwegian banks in structurally identified regressions, we show that the efficiency of the bank lending channel is affected when banks can shift to international funding and thus insulate their costs of funding from domestic monetary policy. We isolate the effect of global factors from domestic monetary policy by focusing on the deviation of exchange rates from the prediction of (uncovered and covered) interest rate parity. The Norwegian banking sector represents an ideal laboratory since the exogenous exchange rate dynamics allows for a convincing identification of the relation between lending and global factors.

ECB Spillovers and Domestic Monetary Policy Effectiveness in Small Open Economies

In this paper, we examine whether financial spillovers from the European Central Bank's monetary policy have consequences for the effectiveness of domestic monetary policy in three small open economies (SOEs) that are highly integrated with the European (Monetary) Union: Denmark, Norway, and Sweden. We find significant spillovers that are particularly strong for longer maturity yields. At the same time, domestic monetary policy in Norway and Sweden is effective for the shorter end of the yield curve, but much less so for the longer end of the curve. Recent work suggests that the trilemma in international economics as we used to know it, may be a dilemma: SOEs can only have effective monetary policies when the capital account is managed. Our results imply something in between: although spillovers impose challenges on domestic monetary policy effectiveness, small open economies still have some control over their yield curve.

The Global Financial Cycle, Bank Capital Flows and Monetary Policy. Evidence from Norway

We investigate the importance of a global financial cycle for gross capital inflows based on monthly balance sheet data for Norwegian banks. The VIX index has been interpreted as an investor fear gauge and associated with a global financial cycle. This index has also been found to impact real activity. We include both a global activity variable and the VIX index in our structural VAR model of capital inflows. We find that when global activity falls, banks' foreign funding share falls. Our results suggest that global real activity rather than a global financial cycle is a main driver behind the volume of bank capital inflows. We also study domestic monetary policy and implications for capital flows. Domestic monetary policy helps absorb VIX shocks and there is no indication of procyclical (carry trade) effects on funding. Monetary policy affects activity and inflation in a standard fashion, and the exchange rate acts as a buffer when shocks hit the economy.