Monetary Policy Signals Research Articles

Monetary policy transmission dynamics: evidence from Indian financial markets

ABSTRACT Our study employs a non-recursive Structural Vector Autoregressive Model (SVAR) to examine to how monetary policy signals transmit across the money, treasury bills, bonds, forex, and the stock market in India and in the process unravel the relative efficacy of various monetary policy signalling instruments on these financial market variables. This exercise is conducted for two distinct monetary policy regimes -Multiple Indicator Regime and Flexible Inflation Targeting Regime. Our results indicate that the transmission of monetary policy differs not only across various segments of the financial markets, but is also sensitive to the choice of monetary policy instruments used by the Reserve Bank of India (RBI) under different regimes. In a bid to heighten the efficacy of monetary policy signals it is hence suggestive that developing economies with high inflation should move towards an inflation targeting regime.

Drivers of WACR-Repo Rate Spread: An Empirical Analysis of India

The spread between the policy rate and operating target rate of the Reserve Bank of India (RBI) has consequences on the transmission of monetary policy signals. Using weekly data from 2011 to 2020 (504 observations), the study employs variants of General Auto Regressive Conditional Heteroskedastic model to comprehensively analyse the factors that drive this spread. Besides the factors retrieved from the literature, this study also gauges the impact of COVID-19 on the spread and its volatility. The results indicate that the spread is significantly impacted by its lag, volume of transactions in the counterpart markets, distribution pattern of the liquidity by the central bank, foreign market intervention, liquidity adjustment facility (LAF), currency in circulation and reserve requirement while market expectations and government cash balances are found to be non-significant. Besides, announcement effect of COVID and changes in key rates are found to be significant. The results of Exponential GARCH do not find significant asymmetry in response to positive and negative shocks on the spread. Volatility in the spread is comparatively more responsive to its lags than to the market shocks.

How Effective Is Monetary Policy Signaling In Nigeria?

How Effective Is Monetary Policy Signaling In Nigeria?

Monetary policy and speculative spillovers in financial markets

This paper examines the role of monetary policy (MP) as a driver of connectedness patterns in speculative activities in financial markets. Examining measures of speculation in four major markets including gold, equities, Treasury bonds and crude oil, we show that speculative activities can spill over across markets with the stock market generally serving as the main transmitter of speculative shocks. While unconventional MP is associated with greater connectedness of speculative activities in financial markets, we also find that unconventional (conventional) MP drives gold (financial assets) to serve as a net transmitter of speculative shocks to the other markets. The findings establish an important link between the monetary policy signals and trading behavior in financial markets with significant policy implications.

The Legality of the European Central Bank's Pandemic Emergency Purchase Programme

The announcement of the Pandemic Emergency Purchase Programme (PEPP) by the European Central Bank on March 18, 2020 marks an unprecedented step in the European history of monetary integration. But it is a commensurate response to the global public health emergency that the COVID-19 outbreak continues to pose as well as the financial and economic shock that it triggered. The legality of the PEPP can be defended in light of both these extraordinary macroeconomic circumstances as well as the European Court of Justice's assessment of previous ECB bond purchase programmes. As this short essay shows, the Court’s Gauweiler and the Weiss decisions have defined the boundaries within which the ECB may design its monetary policy measures. And the PEPP does not transgress these boundaries. However, in order to mitigate the risk of any ex-post legal challenges, the legal act on which the PEPP is based should underscore the following principles, which are informed by the pertinent case law: 1. The PEPP’s objectives are proportional because they address a malfunctioning of the smooth transmission of monetary policy signals across the currency area triggered by the sudden stop of economic activity, thereby undermining the singleness of monetary policy. 2. The PEPP’s design is proportional because it entails the following safeguards: bond purchases are (i) restricted to EUR750 billion, (ii) limited to periods of malfunctioning monetary policy transmission channels, (iii) not selective, (iv) limited to securities with stringent eligibility criteria, and (v) subject to a limited loss-sharing arrangement. 3. The PEPP does not breach the monetary financing prohibition because it (i) has no equivalent effect to bond purchases on the primary markets (due to the safeguards mentioned in 2.) and (ii) does not incentivize Member States pursue unsound budgetary policies.

Monetary Policy and Speculative Spillovers in Financial Markets

This paper examines the role of monetary policy (MP) as a driver of connectedness patterns in speculative activities in financial markets. Examining measures of speculation in four major markets including gold, equities, Treasury bonds and crude oil, we show that speculative activities can spill over across markets with the stock market generally serving as the main transmitter of speculative shocks. While unconventional MP is associated with greater connectedness of speculative activities in financial markets, we also find that unconventional (conventional) MP drives gold (financial assets) to serve as a net transmitter of speculative shocks to the other markets. The findings establish an important link between the monetary policy signals and trading behavior in financial markets with significant policy implications.

Will the New Loan Pricing Norms Achieve Monetary Policy Transmission

A central bank depends on the financial system to ensure smooth and timely monetary transmission. India’s financial system is dominated by banks and any failure of monetary policy signals to reach the economy at large becomes a matter of concern since it indicates that the Reserve bank of India (RBI) has failed to have a favourable impact on the business cycle. Apparently, there have been lopsided responses by banks to RBI’s policy actions. When the monetary policy is tightened through a hike in policy rates, banks are quick to hike interest rates on loans given. When the monetary policy is eased through a reduction in policy rates, banks are slow in reducing interest rates on loans given. The RBI has made attempts to address this issue for quite some time now. It now wants banks to price their loans in kilter with external benchmarks.

IS THERE A “REVERSE CAUSALITY” FROM NOMINAL FINANCIAL VARIABLES TO ENERGY PRICES?

This paper is aimed at examining the association between energy prices and financial variables, but, in contrast to previous works, it explores the possibility of a reverse causality from financial variables towards energy prices from a global perspective considering the world’s four largest world economic poles (the United States, China, the European Union, and Japan), as well as the prices of oil (Brent) and Natural Gas. In order to study the interaction between energy prices and relevant nominal variables (stock market returns, interest rates, and exchange rates), a Panel Vector Autoregression Analysis (PVAR) is carried out. The empirical finding is that Brent Oil and Natural Gas price fluctuations are positively and highly significantly influenced by lagged interest rates, that is, energy markets are sensitive to monetary policy signals and, most likely, to economic agents’ expectations about inflation. Other empirical results also reveal that: 1) lagged exchange rate fluctuations have a negative and significant effect over the stock market; 2) a positive performance of the stock market has a negative effect on the exchange rate, and: 3) that interest rate markets follow their own dynamics independently of the rest of the model variables.

Inflation volatility, monetary policy signaling and clarity of the central bank communication

PurposeStudies about the determinants of the clarity of central bank communication are still scarce. To the authors’ knowledge, there are no studies regarding emerging economies. The purpose of this paper is to contribute to the literature in the following aspects: to analyze the determinants of the clarity of the central bank communication in an inflation targeting emerging economy; observe the influence of inflation volatility over the clarity; and observe the effect of the monetary policy signaling over the clarity.Design/methodology/approachThe work uses readability indexes to measure the clarity of central bank communication. The empirical analysis uses ordinary least squares and the Generalized Method of Moments with one- and two-step estimations.FindingsThe findings suggest the inflation volatility reduces the clarity of central bank communication. Moreover, the monetary policy signaling also affects the clarity, but the effect depends on the direction of the signal.Practical implicationsThis paper observes the determinants of the clarity considering an emerging economy environment. The clarity of central bank communications is an important tool to access transparency. Hence, the analysis of what determines the clarity of central bank communication is a debate about the level of transparency accessed by the central bank.Originality/valueThere are no studies about the determinants of the clarity of central bank communication in emerging economies. Moreover, the novelty are the effects of inflation volatility and monetary policy signaling over the clarity.

What kind of central bank competence?

How much information should a Central Bank (CB) have about (i) policy objectives and (ii) operational shocks to the effect of monetary policy? We consider a version of the Barro-Gordon credibility problem in which monetary policy signals an inflation-biased CB's private information on both these dimensions. We find that greater CB competence---more private information---about policy objectives is desirable while greater competence about operational shocks need not be. When the CB has less private information about operational shocks, the public infers that monetary policy depends more on the CB's information about objectives. Inflation expectations become more responsive to monetary policy, which mitigates the CB's temptation to produce surprise inflation.

Navigating the Trilemma - Capital Flows and Policy Response of the RBI

The theory of ‘Impossible Trinity’ says that if a country, having a fixed exchange rate and open capital account, tries to have an independent monetary policy (like setting higher interest rates than overseas) then it will be frustrated. This paper is an attempt to analyse how the Reserve Bank of India (RBI) navigated the trilemma from 2003-04 to 2011-12 when capital flows surged. Firstly, the RBI used extensive capital controls post 2004 to regulate the capital flows. However it is seen in the paper that although there were a lot of de jure controls, de facto these controls were weakened due to increased pace of financial liberalisation. Secondly, the RBI switched from a monetary targeting framework to a ‘multiple indicator’ approach. Here monetary policy signals were largely transmitted through modulations in policy rates (repo/reverse rates under the daily Liquidity Adjustment Facility). In addition, the RBI used a combination of instruments such as the Cash Reserve Ratio (CRR), open market operations (OMO), Market Stabilization Scheme (MSS) to modulate liquidity in the system. Thirdly our results from the GARCH analysis show that RBI's policy intervention increased volatility. The reason may be that RBI typically intervened in the forex market during times of high volatility and so there was a possibility of RBI's actions adding to the volatility in the market due to uncertainty.

Dynamics of the term structure of interest rates and monetary policy: is monetary policy effective during zero interest rate policy?

The monetary policy targets the short rates; however, during zero interest rate policy (ZIRP), the short end of the yield curve cannot serve as a policy instrument. Relying on the joint yields-macro latent factors model, this study empirically examines the effect of monetary policy stances on term structure and the possible feedback effect on the real sector using the Japanese experience of ZIRP. The analysis indicates that it is the entire term structure that transmits the policy shocks to the real economy rather than the yield spread only. The monetary policy signals pass through the yield curve level and slope factors to stimulate the economic activity. The curvature factor, besides reflecting the cyclical fluctuations of the economy, acts as a leading indicator for future inflation. In addition, policy influence tends to be low as the short end becomes segmented toward medium/long-term of the yield curve. Furthermore, volatility in bond markets is found to be asymmetrically affected by positive and negative shocks and long end tends to be less sensitive to stochastic shocks than the short maturities. The expectation hypothesis of the term structure does not hold during the ZIRP period.

Inferences from Interest Rate Behavior for Monetary Policy Signaling

Weak mean reversion of interest rates towards the long term mean suggests high probability of agents in financial markets failing to interpret monetary policy signalling efficiently and financial market related interest rate unable to achieve equilibrium. Increased randomness penetrating interest rate markets is due to the weak monetary policy signalling effect which dilutes information flow from central banks' to agents in the financial market. In such cases the effectiveness monetary policy erodes as it departs from the objectives

Banks in Disadvantaged Areas

Banks in Disadvantaged Areas Based on the presumption that the empirical banking literature devotes too little attention to institutions with special features, this paper examines banks that are affected by low regional development. Data on the full population of Austrian banks is applied to identify such banks and to study their particular characteristics. It turns out that banks operating in disadvantaged areas differ from their counterparts with respect to individual as well as market–related attributes. Additionally, several effects commonly estimated in empirical banking models prove to be sensitive to the exclusion of these institutions from the estimation sample. These comprise the effect of bank size on the net interest margin, the heterogeneity of loan supply reactions to monetary policy signals which are related to the banks' liquidity position, and the influence of local concentration on competitive behavior. Our findings confirm that key empirical results may be driven by certain groups of banks with special features. Thus, support is provided for the necessity of a more critical view of empirical outcomes for “the average bank”, both from national samples and cross–country studies. (JEL G21, L11, R32) Banken in strukturschwachen Regionen Vor dem Hintergrund, dass empirische Literatur oft zu wenig Augenmerk auf die Heterogenität von Finanzinstitutionen legt, untersucht diese Arbeit Banken in strukturschwachen Räumen. Daten für die Gesamtheit der österreichischen Banken werden herangezogen, um solche Institute zu identifizieren und um ihre speziellen Charakteristiken zu beleuchten. Dabei zeigt sich, dass sich Banken, die von einer schwachen Regionalentwicklung betroffen sind, in vielen Attributen signifikant vom Rest der Kreditinstitute unterscheiden. Zusätzlich kann beobachtet werden, dass sich die Resultate für oftmals in der Bankenliteratur bemühte Zusammenhänge verändern, wenn diese Banken aus der Datenbasis entfernt werden. Dies ist im konkreten Fall zutreffend für den Einfluss der Bankengröße auf die Nettozinsmarge, für die Reaktion der Kreditvergabe auf geldpolitische Impulse in Abhängigkeit von der Liquiditätssituation und für den Effekt von Konzentration in lokalen Märkten auf das Wettbewerbsverhalten. Die Ergebnisse dieser Arbeit lassen vermuten, dass manch empirisches Resultat auf gewisse Bankengruppen mit bestimmten Eigenschaften zurückführbar ist. Daher sollten darauf basierende Aussagen, die “die durchschnittliche Bank“ betreffen, kritischer unter die Lupe genommen werden.

Signalling Effects of Monetary Policy in Nigeria: Evidence from the New Central Bank’s Communication Regime: 2005-2011

This paper uses daily data for the period 2005-2011 to estimate the effects of monetary policy signals on the Nigeria Interbank Offer Rates. After controlling for the contemporaneous effect of the policy action taken at each meeting of the Monetary Policy Committee, we found that these rates are significantly more volatile in the weeks the meetings hold. We identify the higher volatility of the rates as the signalling effect of monetary policy communication. This, we argue, suggests that central bank communications is potentially a viable tool of monetary policy implementation in Nigeria. The paper suggests that the Central Bank of Nigeria should be careful in communicating to the markets and should have an optimal communication strategy.

Signalling vs. Cost-of-Fund Effects of Monetary Policy in Nigeria: Evidence from the Post-Banking Sector Consolidation Data

The communique of the meeting of the Monetary Policy Committee provides two separate sets of information to the financial market, each of which can have separate effects on the overall policy outcome. First, it contains information on the policy decision, typically in the form of a change in the Monetary Policy Rate (MPR). This change in the MPR affects other rates in the market because it represents a change in the cost of funds to the banks. This is the so-called cost-of-funds effect of monetary policy. Secondly, the communique also typically contain some information that signal the future direction of monetary policy. These signals are likely to affect the market expectations, and therefore affect the term-structure of interest rates. This is the signalling effect of monetary policy. This paper uses daily data for the period 2009-2011 to estimate the separate effects of monetary policy signals and cost of funds on the interbank call rate and open buy-back rate. We found that the cost-of-money effect on the Open Buy Back rate is larger than it is on the call rate. The effect of monetary policy signals on both rates is however found to be quite significant. This, we argue, suggests that central bank communications is potentially a viable tool of monetary policy design and implementation in Nigeria. The paper therefore suggests that the CBN should be proactive in designing an optimal communication strategy.

Monetary Policy Transmission in Ghana: Does the Interest Rate Channel Work?

This paper analyzes interest rate pass-through in Ghana. Time series and bank-specific data are utilized to highlight linkages between policy, wholesale market, and retail market interest rates. Our analysis shows that responses to changes in the policy interest rate are gradual in the wholesale market. Prolonged deviation in the interbank interest rate from the prime rate illustrate the challenges the Bank of Ghana faces when targeting a short-term money market interest rate. Asymmetries in the wholesale market adjustment possibly relate to monetary policy signaling, weak policy credibility, and liquidity management. In the retail market, pass-through to deposit and lending interest rates is protracted and incomplete.1

Monetary Policy Transmission in Ghana: Does the Interest Rate Channel Work?

This paper analyzes interest rate pass-through in Ghana. Time series and bank-specific data are utilized to highlight linkages between policy, wholesale market, and retail market interest rates. Our analysis shows that responses to changes in the policy interest rate are gradual in the wholesale market. Prolonged deviation in the interbank interest rate from the prime rate illustrate the challenges the Bank of Ghana faces when targeting a short-term money market interest rate. Asymmetries in the wholesale market adjustment possibly relate to monetary policy signaling, weak policy credibility, and liquidity management. In the retail market, pass-through to deposit and lending interest rates is protracted and incomplete.1

US Treasury primacy in monetary policy signalling: a public choice perspective

This note reviews the signalling models presented in the monetary economics literature, and offers a supplementary interpretation regarding the observed US Treasury primacy in signalling. It is argued here that the legal authority given to the US Treasury, under the Gold Reserve Act of 1934, for managing the exchange value of the dollar in international markets provides an avenue for the Treasury, and thus the Administration (i.e., the Executive Branch), to use foreign exchange intervention policy to reduce the credibility of the Federal Reserve's monetary policy. This legal relationship is likely the source of much tension between the two institutions, especially during periods for which the Administration and the Federal Reserve are at odds regarding the proper direction for monetary policy. Given that the Federal Reserve is aware of this implicit power of the Treasury, it should not be surprising that monetary policy signals from that quarter have been found to have a dominant influence on monetary policy.

How effective are monetary policy signals in India?

The signalling mechanism of monetary policy is of vital importance as it conveys the central bank's assessment of the economy and its future outlook. In the Indian context, changes in the policy environment since the later half of the 1990s have brought about shifts in the operating procedure of monetary policy. As a result, beside the traditional instruments, new indirect instruments have emerged as tools of monetary policy signalling. Against this backdrop, we examine the efficacy and robustness of alternative monetary policy instruments in transmitting policy signals and its impact on financial market behaviour. Employing a SVAR model, we ascertain whether the gradual emphasis on indirect instruments have facilitated the task of conveying the monetary policy stance and also provide evidence of asymmetric response of financial markets to monetary policy shocks.