Monetary Policy Process Research Articles

The transmission of monetary policy shocks through the markets for reserves and money

This paper identifies supply and demand curves for bank reserves and a Divisia aggregate of monetary services within a structural vector autoregressive time-series model. Estimated over four sample periods spanning 1967 through 2020, the model illustrates how monetary policy actions can be interpreted with reference to their initial impact on bank reserves and the federal funds rate and their subsequent effects on Divisia money, nominal consumption spending, the aggregate nominal price level, and the unemployment rate. Model estimates attribute strong inflationary effects to monetary policy in the late 1960s and 1970s and also show that changes in the supply of reserves associated with the Fed's large-scale asset purchases since 2008 worked, as intended, to offset deflationary pressures and reduce unemployment. The model describes a much richer monetary policy process than one focused on interest rates alone.

Exchange rate hedged deposit account as a macroprudential monetary policy instrument

Purpose - In the aftermath of the 2008 global financial crisis, central banks have resorted to macro discretionary monetary policies in order to prevent the risks that the fragility of macroeconomic indicators in national economies may pose on financial stability. Accordingly, in December 2021, the CBRT initiated a comprehensive monetary policy process that will provide long-term and permanent returns in the fight against high inflation and high exchange rates, and introduced the "Currency Protected Deposit" instrument to encourage and support real persons to make their investment preferences in TL. The liraization process and exchange rate-protected deposits are aimed to make a lasting contribution to price stability in the medium term. In this study, the purpose of the Exchange Rate Protected Deposit (ERD) scheme and its impact on macroeconomic indicators will be evaluated for the 2021-2023 period. Methodology - After explaining the implementation, characteristics and the need for the KKM, the impact of the utilization rate of the KKM on the exchange rate and interest rates in the December 2021-December 2023 period is evaluated.. Findings - With the KKM implementation, which aims to contribute to strengthening macro financial stability by supporting Turkish lira time deposits, the utilization rate of the KKM is seen to have contributed to the strengthening of the monetary transmission mechanism through the increase in the policy rate, the increase in the demand for Turkish lira instruments, and the rise in loan and deposit rates together. Turkish lira deposits are on the rise while FX-protected deposits are on the decline. Conclusion - It is observed that the KKM' implementation contributed to the lira appreciation process and partially contributed to the recovery in exchange rates between December 2021 and July 2023. Keywords: Currency protected deposit, macroprudential monetary policy, exchange rate JEL Codes: H30, E52, F31

Research on the Influence of Monetary Policy on Stock Market Return

These changes in China's stock market are influenced by factors such as the share-trading reform and the international financial crisis. During this period, a series of monetary policies implemented in China also had some profound effects on China's stock market. Capital market has always been the main transmission channel of monetary policy. In recent years, China's interest rate system, share-trading system and other reforms have been gradually implemented, and the reform of interest rate marketization has achieved certain results, but it has also brought more uncertainty to the transmission of stock market and monetary policy. With the continuous expansion of the stock market, it has played an important role in the transmission process of monetary policy. At the same time, monetary policy can affect the price of financial assets, thus changing people's behavioral decisions and achieving monetary policy goals. When the actual monetary policy changes beyond or below expectations, it will cause the change of stock price. The existence of expectation effect makes the relationship between monetary policy and stock price change more complicated: taking loose monetary policy as an example, when the actual degree of easing is greater than investors' expectations, stock prices will be positively stimulated by easing; When the degree of easing is less than investors' expectations, the stock price will turn downward. Therefore, it is worth studying to analyze the influence mechanism among monetary policy, stock market and real economy.

Engaging central banks in climate change? The mix of monetary and climate policy

Given the recent debate on the role of central banks under climate change, this research theoretically investigates the mix of monetary and climate policy and provides insights for central banks who are considering their engagement in the climate change issue. The “climate-augmented” monetary policy is pioneeringly proposed and studied. We build an extended Environmental Dynamic Stochastic General Equilibrium (E-DSGE) model as the method. By this model, we find the following results. First, the making process of monetary policy should consider the existing climate policy since it is a factor that can influence price level and inflation. Second, the reaction coefficients in traditional monetary policy rule can be better set to enhance welfare when climate policy is given. This provides a way to optimise the policy mix. Third, if a typical-form climate target is augmented into the monetary policy rule, a dilemma could be created. This means that it has some risks for central banks to care for the climate proactively by using the narrow monetary policy (interest rate).

Spillover effect of United States Monetary Policy on Nigeria’s Financial and Macro Fundamentals

This paper examines spillover effects of U.S monetary policy on macroeconomic fundamentals in Nigeria from January 1985 to December 2018. The study period is partitioned to account for conventional monetary policy (CMP) period, January 1985 to August 2007 and unconventional monetary policy (UMP) period, September 2007 to December 2018. Guided by relevant pre-tests, we find BEKK-VARMA-CCCMGARCH as the most appropriate model. The study finds significant spillover effects of U.S CMP and UMP on interest rate, exchange rate and inflation rate in Nigeria. We, however, observe that while CMP may be a significant accelerator of shocks persistence on interest rates and exchange rates, the extent to which the UMP accelerate shocks in inflation rate tends to vary for different measures of quantitative easing. Thus, in addition to past own shocks and past own conditional variance of these macro fundamentals, understanding their dynamics cannot be in isolation of their vulnerability to external shocks and volatility due to spillover effects of monetary actions in other economies. In formulating monetary policy, it is therefore, imperative for the Central Bank of Nigeria to monitor the monetary policy process of the US to hedge against shocks spillovers.

Monetary policy framework in India.

In 2016, the monetary policy framework moved towards flexible inflation targeting and a six member Monetary Policy Committee (MPC) was constituted for setting the policy rate. With this step towards modernization of the monetary policy process, India joined the set of countries that have adopted inflation targeting as their monetary policy framework. The Consumer Price Index (CPI combined) inflation target was set by the Government of India at 4% with ± 2% tolerance band for the period from August 5, 2016 to March 31, 2021. In this backdrop, the paper reviews the evolution of monetary policy frameworks in India since the mid-1980s. It also describes the monetary policy transmission process and its limitations in terms of lags and rigidities. It highlights the importance of unconventional monetary policy measures in supplementing conventional tools especially during the easing cycle. Further, it examines the voting pattern of the MPC in India and compares this with that of various developed and emerging economies. The synchronization of cuts in the policy rate by MPCs of various countries during the global slowdown in 2019 and the COVID-19 pandemic in the early 2020s is also analysed.

Dynamic Expectations Formation and U.S. Monetary Policy Regime Change

This essay studies the fundamental causes of the monetary policy regime switches within rational expectations models. I introduce a threshold-switching monetary policy process into the model that links the policy stance to the fundamental shocks by an autoregressive regime strength index. It creates an expectations feedback mechanism between private agents’ policy forecasts and future policy regime outcomes. As demonstrated in a novel threshold-switching Fisherian model, well management of the private sector’s expectations of policy regime change can have the same effect as actually switching the regime. Contrastingly, failure to do so leads to unfavorable outcomes of policy intention. Then, I embed the new mechanism into a New Keynesian model. Along the way, I also develop an efficient non-simulation based threshold-switching Kalman filter, in conjunction with a solution method that accounts for the endogeneity of switching regimes, to estimate the nonlinear New Keynesian model. My key empirical findings are threefold. First, non-policy shocks have been instrumental in driving U.S. monetary policy regime changes during the post-World War II period. Most notably, markup shock explains 65.6% of variations in the policy regimes. Second, absent from markup shocks, eight of the eleven less aggressive regimes would not have happened during this history. Finally, I conclude that linking the private sector’s dynamic expectations formation and the Fed’s dilemma of the dual mandate in the presence of adverse supply shocks is a promising path towards providing micro-foundations for monetary policy regime shifts.

The Rise of the US Federal Reserve as a World Monetary Authority: Revisiting the Volcker Shock

In the existing International Political Economy literature, the Volcker Shock has been widely regarded as historical significance in the development of international political economy. Three successive waves of IPE have evolved to highlight it respectively, as a subjugation of the US state to pressures of foreign states, to international financial power, and institutional configurations of US financial power. Without close attention to the particular role of the US Federal Reserve, however, these observations obscure the unprecedented process of a new mode of monetary governance. This paper argues that the Volcker Shock ushered in the rise of the US Federal Reserve as a world monetary authority in a way that the inner-making process of autonomous monetary policy became a new way of governing monetary and financial affairs. The Federal Reserve was able to pursue autonomous monetary policy far away from the economic management of the US government and at the same time to discipline banks in international financial markets. The Federal Reserve eventually established itself as a new kind of monetary authority between US government and international financial markets. This paper contributes to the study of international monetary power.

Asymmetric effects of unanticipated monetary shocks on stock prices: Emerging market evidence

This study investigates the asymmetric effects of unanticipated monetary shocks on stock prices in India over the period 1994M4–2018M11. We find that the evolution of stock prices is state-dependent across different monetary policy processes. Unanticipated monetary shocks appear to have significantly asymmetrically lagged effects on stock prices, namely: (i) the positive effect of negative unanticipated shocks in bull markets; and (ii) the negative effect of positive unanticipated shocks in bear markets. Our findings imply that monetary policy-markers should attend to these situations for the future of money-supply policies to diminish the degree of uncertainty about the money supply in adjusting stock prices.

Inflation Dynamics and Impact of Demand and Supply Shocks:Evidence from India

This present article tries to comprehend the dynamics of inflation with respect to both core and headline measures of inflation. To understand the dynamic movement in both the measures of inflation, first core inflation is calculated using the traditional exclusion measure (excluding food and energy), and statistical measure using the trimmed mean approach by considering monthly Combined Consumer Price Index (CPI) y-o-y cross-sectors headline distribution of data from January 2012 and December 2018. Next, a comparative study is attempted to know the reaction of both core and headline inflation measures to different demand and supply shocks by the Structural Vector Autoregressive Techniques. Based on empirical analysis, it is proved that 20 per cent trimming of the extremely volatile components from the headline inflation can be considered as a better proxy for core inflation series. Core inflation series by trimming 20 per cent has the better predictive ability for the underlying trend in the overall inflation. In addition, empirical findings further show that core inflation is more responsive to demand shocks, suggesting that core inflation is mostly affected by real economic activity whereas the fluctuation in headline inflation, on the other hand, is more explainable by supply side factors in India. It is much more volatile. Thus, considering headline inflation in the decision making process of the monetary policy in the determination of policy rates can contribute to biasness and hence affect the long term objective of inflation targeting. Variations in core inflation are more observed due to monetary policy behaviour and hence making it an important component in the policy decision making.

THE APPLICATION OF MONETARY INCENTIVE POLICY IN CURRENT ECONOMIC CONDITIONS

The aim of the article is studying the process of implementation of promotional monetary policy by investigation of the functionality of the transmission mechanism channels. The paper singles out the peculiarities of the implementation of monetary policy in well-developed and developing countries. The subject of the study is: the structure of the monetary transmission mechanism; the functionalities of both traditional and non-traditional channels and their influence on promotional monetary policy are defined. An analysis of the existing structure of the transmission mechanism made it possible to determine the strength and speed of feedback between participants and the degree of influence on the real sector and to formulate appropriate proposals for its adjustment or activation. In addition, it is indicated that, under the present conditions, it is non-traditional channels that acquire special significance; also, the main factors that have shifted the priority vector in their direction are defined. Alongside this, the study presents modern modifications of promotional monetary policy and their significance for the modern economic world. Methodology. The classic methods of scientific research are used in the article, among which are the following: observation, abstraction, comparison, systematic approach, analysis, and synthesis. Results. The conducted study clearly demonstrates that, in the process of changing financial relations, the significance of the transmission mechanism channels in the process of implementing promotional monetary policy changed, too. At the same time, it is expedient to single out the reasons that lead to a change in the role of some channels of monetary transmission in relation to others. Current research and developments are not limited to the above structure of the transmission mechanism channels. Moreover, their list is constantly replenished, which is indicative of the existence of transformational processes affecting the financial sector. The approaches to the structure of the transmission mechanism and the functionality of its channels, determined in this article, make it possible to assess the effectiveness of implementing monetary policy. Practical implications. Clarified complex causes of destructive nature, which initially level out practically any actions with regard to the system approach, namely, the absence of the integrated combination of interests of all social and economic spheres: state-business-society. Also, the results of the study provide an opportunity to identify further trends in the changing transmission mechanism channels in the implementation process of monetary policy and use this knowledge by planning and forecasting for the functionality of transmission channels. Value/originality. This research was carried out within the framework of the scientific work of the Department of Theoretical and Applied Economics of the National Technical University of Ukraine “Igor Sikorsky Kyiv Polytechnic Institute” (No. 0112U007817) on the topic: “Globalization of industrial capacity formation trends in the terms of post-industrial transformation”.

Whose confidence matters in Chinese monetary policy?

Whose confidence matters in Chinese monetary policy—consumers or entrepreneurs? To answer this question, we first conduct a competition test between the two groups and find that the entrepreneurs' confidence plays a much more dominant role than the consumer confidence in the transmission process of monetary policy. In addition, we use counterfactual structural vector autoregression method to isolate and identify the effect of confidence. The empirical results show that the effectiveness of proactive monetary policy will be strikingly reduced if the channel of entrepreneurs’ confidence is shut down. Removing the effect of consumer confidence from the system, however, produces little impact on the effectiveness of monetary. These findings are robust to both price-based and quantitative-based policy variables in China.

It Is Time to Resolve Nigeriaas Monetary Policy Conundrums

In the last six years, Monetary Policy Committee (MPC) decisions have included easing the monetary policy rate (MPR) just once, November 2015, and the cash reserve requirement (CRR) has been eased just twice, July and November 2015. In contrast, the MPR has been tightened ten times, including twice during the recession in 2016, and the CRR has also been tightened ten times, including once in 2016. It is very puzzling that MPC finds extraneous reasons, typically about banks or foreign exchange supply, to tighten monetary policy, even when the economy is contracting and can do with some liquidity boost. This paper demonstrates how MPC decisions have become disconnected from economic realities, and suggests the urgent steps that must be taken to ensure a reconnect. We compare the patterns in historical monetary policy decisions across Soludo, Lamido, and Emefiele regimes to trace the emergence of the disconnect and establish the best strategies for reconnecting. We also clarify the numerous misconceptions about the nominal MPR, positive real interest rate, foreign portfolio inflows that are often expressed in the MPC communiques. The economy is bigger and more important than the banks, but MPC statements continue to dwell on banks’ conditions, rather than on economic conditions, indicative of lapses in banking supervision. Failures of micro/macro-prudential policies are spilling over into the monetary policy space, inflicting high growth and employment costs on the economy. What the UK government has done in reforming the Bank of England over the last two decades, especially in functionally separating responsibilities for monetary policy and micro/macro-prudential policies, is an example of the reforms required in Nigeria. Apart from banks’ conditions, MPC statements have also had a lot to say about the need to keep the policy rate high enough to attract foreign portfolio inflows, rather than ease rates to stimulate growth and investment, betraying another spill-over into the monetary policy space from weaknesses in the foreign exchange policies of the Central Bank of Nigeria (CBN). Nigeria’s foreign investment policy must be recalibrated away from preoccupation with volatile and easily reversible portfolio inflows towards greater reliance on harder to reverse diaspora and foreign direct investment inflows. We argue strongly for immediate reforms in Nigeria’s monetary policy processes, Nigeria’s banking supervision arrangements, and Nigeria’s foreign investment policies. Those reforms are needed to ensure an orderly transition to a low MPR/low CRR regime that is urgently needed to boost growth and investment.

Micro and Macroprudential Perspectives of Bankss Surveillance: Implications for the Trade-Off between Benefits and Costs of Regulation

The traditional approach to bank regulation, and notably to capital requirements, is based on microprudential cost-benefit analyses. The emphasis is, therefore, on rules that aim at ensuring that each and every banking firm is safe and sound. This note examines possible extensions of the approach: to allow for fallacies of composition of the micro dimension, to explore the macroprudential implications of capital regulatory burdens and to take into account the regulatory implications of complex systems. In particular, capital requirements may blunt monetary and credit policy processes. In any event, costs and benefits must be assessed under different states of the world. The trade-off between benefits and costs is specifically considered during prolonged periods of perturbed economic conditions and for banks of different size.

Small DSGE Model with Financial Frictions

In the last few years, macroeconomic modelling has emphasised the role of credit market frictions in magnifying and transmitting nominal and real disturbances and their implication for macro-prudential policy design. In this paper, we construct a modest New Keynesian general equilibrium model with active banking sector. In this set-up, the financial sector interacts with the real side of the economy via firm balance sheet and bank capital conditions and their impact on investment and production decisions. We rely on the financial accelerator mechanism due to Bernanke et al. (1999) and combine it with a bank capital channel as demonstrated by Aguiar and Drumond (2007). We calibrate the resulting model from the perspective of a low income economy reflecting the existence of relatively high investment adjustment cost, strong fiscal dominance, and underdeveloped financial and capital markets where the central bank uses money growth in stabilizing the national economy. Then we examine the impulse response of selected endogenous variables to shocks stemming from the fiscal authority, the monetary policy process, and technological progress. The findings are broadly consistent with previous studies that demonstrated stronger role for credit market imperfections in amplifying and propagating monetary policy shocks. Moreover, we also compare the trajectory of the model economy under alternative monetary policy instruments. The results suggest that the model with money growth rule generates higher volatility in output and inflation than the one with interest rate rule.

Interest Rates, Policy Uncertainty, and Investment

In this paper, I estimate a cointegrated VAR with three long run equilibrium conditions that are consistent with the New Keynesian model. The equilibrium conditions estimated in the VAR do not provide evidence of a negative relationship between the federal funds rate and investment, or output more generally. Economic policy uncertainty, however, does have a negative and statistically significant effect on investment in the estimated model. I argue that the results support an option theory view of investment rather than the standard New Keynesian model. Also, various specifications of the model demonstrate that the findings are robust to an alternative short term nominal interest rate, the use of real interest rates rather than nominal interest rates, different classifications of investment, different measures of economic uncertainty, and a different specification of the monetary policy process. In addition, I argue that the results have implications for the weak recovery in the aftermath of the Great Recession. In particular, the results suggest that the increase in economic policy uncertainty observed after 2007 can potentially explain the weak recovery whereas the results cast doubt on the significance of the zero lower bound on nominal interest rates.

Effectiveness of the monetary policy implemented in the context of crisis: use of short-term interest rate in the Czech Republic and the EMU

Focus on monetary policy transmission mechanism has regained its importance especially in regards to fi nancial and debt crisis. Negative developments after 2008 still verify the ability of monetary policy to mitigate its impacts. In EMU, it can be seen in the case of the effects of single monetary policy and the deepening of the asymmetries between member countries. This can be compared to the case of the monetary policy ef fi ciency in small and open non-member country and its in fl uence on macroeconomic developments. This paper is focused on the analysis of transmission process of monetary policy through the interest rate channel in EMU as well as in a non-member country, namely in Czech Republic. The aim of the analysis was to verify the similarity of reaction in case of monetary policy shock. The results for Czech Republic were compared to results for overall EMU. The focus was predominantly on interest rate channel of monetary transmission process and its impact on in fl ation, nominal effective exchange rate and gross domestic product, the variables that are typically used in central banks’ monetary rules. We also assumed that negative developments related to the crisis can distort the transmission of monetary policy effects on macroeconomic variables and that the impact of monetary policy changes is transmitted to the economic variables only partially or signi fi cantly lagged. The effects of interest rate shocks on selected variables were identi fi ed by estimating VAR model that uses Cholesky decomposition of innovations; the most widely used empirical methodology for analysing the transmission mechanism of monetary policy. The results show that the reactions of the product and the price level to positive interest rate shock are very similar for Czech Republic as well as for EMU throughout the investigated period 1999–2013. However, we cannot de fi nitively af fi rm that the crisis disrupted the transmission process from monetary measures to analysed macroeconomic variables as shown in the cases of Czech Republic and EMU. Interest rate channel has not shown particularly strong and stable in fl uence on the observed variables neither for Czech Republic, nor for EMU.

Book Reviews

Donato Masciandaro of Bocconi University reviews, “Bankers, Bureaucrats, and Central Bank Politics: The Myth of Neutrality” by Christopher Adolph. The Econlit abstract of this book begins: “Presents a new approach to the politics of money, focusing on the role played by central bankers and their preferences. Discusses agents, institutions, and the political economy of performance; career theories of monetary policy; central banker careers and inflation in industrial democracies; careers and the monetary policy process—three mechanism tests; careers and inflation in developing countries; how central bankers use their independence; partisan governments, labor unions, and monetary policy; the politics of central banker appointment; the politics of central banker tenure; and the dilemma of discretion. Adolph is Assistant Professor of Political Science, Adjunct Assistant Professor of Statistics, and a core faculty member of the Center for Statistics and the Social Sciences at the University of Washington, Seattle.”

A Medium Scale Forecasting Model for Monetary Policy

This paper presents a 16-variable Bayesian VAR forecasting model of the U.S. economy for use in a monetary policy setting. The variables that comprise the model are selected not only for their effectiveness in forecasting the primary variables of interest, but also for their relevance to the monetary policy process. In particular, the variables largely coincide with those of an augmented New-Keynesian DSGE model. We provide out-of sample forecast evaluations and illustrate the computation and use of predictive densities and fan charts. Although the reduced form model is the focus of the paper, we also provide an example of structural analysis to illustrate the macroeconomic response of a monetary policy shock.

Monetary shocks and central bank liquidity with credit market imperfections

This paper analyses the transmission process of monetary policy in a closed-economy New Keynesian model with monopoly banking and a cost channel. The loan rate depends on the repayment probability, which in turn depends on firms' net worth and cyclical output. The supply of bank loans is perfectly elastic at the prevailing loan rate and so is the provision of central bank liquidity at the policy rate. Numerical simulations, based on an illustrative calibration, show that credit market imperfections and sluggish adjustment of bank deposit rates may impart a substantial degree of persistence in the response of output and inflation to monetary shocks. With flexible wages, a relatively high elasticity of the repayment probability with respect to cyclical output is required for a monetary contraction to lead to higher inflation, that is, to a price puzzle. Copyright 2012 Oxford University Press 2011 All rights reserved, Oxford University Press.