Monetary Policy Reaction Research Articles

Supply shocks and monetary policy responses in emerging economies

Supply shocks bring about important dilemmas for monetary policy in emerging economies. We compute monetary policy responses to supply shocks using quarterly data and a Bayesian panel VAR for 24 emerging economies during the period 2004–2019. In this framework, we identify supply shocks as unexpected and temporary total factor productivity innovations which are orthogonal to demand related shocks. We highlight three results from this econometric exercise. First, monetary policy is, in average, procyclical in emerging economies after temporary supply shocks. Second, monetary policy is more procyclical in fixed than in flexible exchange-rate regimes. Third, monetary policy is more procyclical in economies with a higher degree of financial openness. The latter result is a central dilemma for emerging economies during supply shocks, since it implies that financial openness prevents less procyclical monetary policy reactions due to the trade-off between exchange rate and income volatility.

Milton Friedman and the Road to Monetarism: A Review Essay

Milton Friedman and the Road to Monetarism: A Review Essay

Forward-Looking Policy Rules and Currency Premia

AbstractWe evaluate the cross-sectional predictive ability of a forward-looking monetary policy reaction function, or Taylor rule, in both statistical and economic terms. We find that investors require a premium for holding currency portfolios with high implied interest rates while currency portfolios with low implied rates offer negative currency excess returns. Our forward-looking Taylor rule signals are orthogonal to current nominal interest rates and disconnected from carry trade portfolios and other currency investment strategies. The profitability of the Taylor rule portfolio spread is mainly driven by inflation forecasts rather than the output gap and is robust to data snooping and a wide range of robustness checks.

Impossible Trinity in a Small Open Economy: A State–Space Model Simulation

Should monetary policy independence be maintained when the exchange rate is fixed under closed capital account conditions in a small open economy? In this study, we simulate the impossible trinity condition during 1989 to 2019 on the Nepalese economy that restricts capital flows and fixes the exchange rate with India. We modify the traditional Taylor rule based on the monetary policy reaction function to characterize Nepal's economic conditions more closely. The state–space model simulation shows that the policy trilemma does not hold in Nepal, such that the model can predict interest rate when the weight for domestic conditions is assigned at a substantially lower level. Therefore, the existing policy mix may need to be revisited to maintain monetary policy independence. Nepal might consider devaluing its currency to neutralize the adverse effects of the negative risk premium and ameliorate the real exchange rate appreciation in the short run and explore alternative arrangements in the long run.

When does the fed care about stock prices?

We propose a novel identification approach based on a predictable change in the intraday volatility of index futures to estimate the Federal Reserve's reaction to stock returns. This identification approach relies on a weaker set of assumptions than required under identification through heteroskedasticity based on lower frequency data. Our approach also allows the examination of changes in the reaction of monetary policy to the stock market. We document an asymmetric response of policy expectations to changes in stock prices in adverse and positive economic environments. Specifically, the results show a sharp increase in the response of monetary policy expectations to stock returns during recessions and bear markets. This finding is consistent with the existence of the so-called “Fed put.”

Monetary policy reaction function and the financial cycle

We examine whether the systematic response of monetary policy to financial imbalances matters for financial stability. We measure how responsive the Federal Reserve's policy is to imbalances in the equity, housing and credit markets. We find that changes in these policy sensitivities predict the subsequent development of financial imbalances. When monetary policy responds more counter-cyclically to market overheating, imbalances tend to decline over time. This effect is distinct from that of current and anticipated interest rate levels – the risk-taking channel. The evidence highlights the importance of the systematic component of monetary policy reaction function in shaping the financial cycle.

Evaluating the Role of the Exchange Rate in Monetary Policy Reaction Function of Advanced and Emerging Market Economies

Abstract The subject of this paper is the evaluation of monetary policy reaction function on panel data of 37 world economies, both advanced and emerging markets, during the period of 1995Q1 – 2018Q3. The paper aims to evaluate the role and importance of the exchange rate in monetary policy reaction function depending on the level of economic development. For this purpose, a relevant set of unbalanced panel data was formed with a balanced relationship between developed and emerging market economies. The methodology of empirical research is based on the econometric assessment of monetary policy reaction function within which the central bank adjusts its key policy rate to the dynamics of inflation, output gap and fluctuations of the real effective exchange rate. The research results confirm the hypothesis that the exchange rate represents a statistically significant variable only in the monetary policy reaction function of emerging market economies. In contrast, adequate specification of developed economies’ monetary policy rule includes only standard macroeconomic fundamentals – inflation and output gap.

Credit economy of banks during SARS-CoV-2

Each pandemic is the greatest potential, negative and global risk, especially when it is connected with high morbidity and mortality. There are also negative social and economic effects associated with a pandemic. The world is fighting nowadays against the COVID-19 pandemic, which is caused by SARS-CoV-2. Thus, there is high concern about the global economy. In the opinion of some analysts, COVID-19 will contribute to the global recession.
 It is worth emphasizing that the Polish Financial Supervision Authority, the Financial Stability Committee, as well as the National Bank of Poland undertake actions focused on introduction of measures aimed at maintaining the availability of credit for entrepreneurs. At the same time, the Polish Bank Association (ZBP) initiated some facilitations for bank customers with regard to paying off liabilities, as well as extending the period of the loan itself (A. Sieroń, 2021).
 For those involved in observation of central banks activities, it is obvious that the monetary policy reaction to the situation resulting from the COVID-19 pandemic is dictated by many reasons, and thus, is considered to be exceptional. The purpose of this analysis is to examine in a systematic manner some of the aspects of the above unique situation and to make some comments. The observations described in the paper result only from information relating to the initial reactions of banks to the situation connected with the COVID-19 pandemic. It would be wrong to say that banks can be considered completely safe today. New economic and social events could contribute to the inefficiency of this sector. One of such event is the COVID-19 pandemic. In the long run, there may be more risks of this kind.

Financial stability and monetary policy reaction: Evidence from the GCC countries

This paper investigates the interaction between monetary policy and financial stability in the Gulf Cooperation Council (hereafter GCC) countries by introducing a new composite financial stability index to monitor the financial vulnerabilities and crisis periods. To this end, the study estimated monetary policy reaction functions for each GCC country (namely, Bahrain, Kuwait, Saudi Arabia, and the United Arab Emirates) using the Nonlinear Autoregressive Distributed Lag Model (NARDL) over the period from 2006-Q4 to 2020-Q2. Empirical findings indicate that monetary authorities' response to the deviation of inflation from their target level, output gap, or exchange rate movement differ in magnitude, sign, and significance across the GCC countries. The results further explain that monetary authorities react significantly to negative or positive shocks to financial stability, but they react differently in the short or long term. Overall, an augmented Taylor rule including financial stability as an additional monetary policy target is more appropriate for the GCC countries.

Algorithms for inference in SVARs identified with sign and zero restrictions

Summary I develop algorithms to facilitate Bayesian inference in structural vector autoregressions that are set-identified with sign and zero restrictions by showing that the system of restrictions is equivalent to a system of sign restrictions in a lower-dimensional space. Consequently, algorithms applicable under sign restrictions can be extended to allow for zero restrictions. Specifically, I extend algorithms proposed in Amir-Ahmadi and Drautzburg (2021) to check whether the identified set is nonempty and to sample from the identified set without rejection sampling. I compare the new algorithms to alternatives by applying them to variations of the model considered by Arias et al. (2019a), who estimate the effects of US monetary policy using sign and zero restrictions on the monetary policy reaction function. The new algorithms are particularly useful when a rich set of sign restrictions substantially truncates the identified set given the zero restrictions.

Estimating asymmetries in monetary policy reaction function: an oil price augmented Taylor type rule for Nigeria under unconventional regime

Estimating asymmetries in monetary policy reaction function: an oil price augmented Taylor type rule for Nigeria under unconventional regime

Interest rate setting in Egypt: a NARDL approach for estimating backward-looking monetary policy reaction function

ABSTRACT The role of inflation versus output and exchange rate in designing monetary policy in Egypt has been subject to considerable debate in literature, even after the proclamation of price stability as the monetary policy objective in 2004 and the adoption of flexible exchange rate system in 2016. This study aims to investigate the main drivers of interest rate setting in Egypt throughout the period from 2005 to 2019. In this context, both an ARDL and NARDL econometric techniques are employed to estimate the backward-looking augmented Taylor monetary policy reaction function. The estimated equation estimates policy rate as a function in lagged inflation, lagged output gap, lagged policy rate, change in real effective exchange rate, in addition to other variables. The importance of this study arises from the lack of recent studies assessing interest rate setting in Egypt. The study concludes that monetary policy in Egypt has been accommodative to inflation and that Central Bank of Egypt responds asymmetrically to shocks in inflation, output and exchange rate.

Asymmetries in the monetary policy reaction function: evidence from India

Abstract This paper analyzes the reaction function of monetary authority in India from 1997Q 1 to 2019Q 4 using nonlinear Taylor rule. It has been found that monetary policy reaction function (MPRF) in India is asymmetric and is influenced by the state of the economy, determined by the lagged interest rate. To capture such asymmetry, we have used a set of nonlinear models including smooth transition regression (STR) model, threshold regression (TR) model and Markov-switching regression (MSR) model along with the instrumental variable estimation technique. The analysis discloses that the behaviour of the Reserve Bank of India (RBI) is asymmetric, reacts aggressively to output gap in general and particularly during periods of high interest rate. Furthermore, the RBI reacts more to inflation and output gap during low volatile regimes in MSR models compared to high volatile regimes. We also found that there is a high degree of inertia in the policy rates of the RBI. The study concludes that nonlinear models may not only help in understanding the behaviour of the RBI but also prevent from making incorrect and misleading conclusions in Indian context.

COVID-19 and Monetary policy with zero bounds: A cross-country investigation

Using daily data on policy rates from 28 advanced economies and 32 emerging markets, this paper investigates the monetary policy reaction function of central banks during the Coronavirus Disease 2019 (COVID-19) outbreak. The results show that emerging markets or countries without a zero bound on their interest rates were able to reduce interest rates as a reaction to reduced economic activity and to the volatility in their exchange rates, whereas advanced economies or countries with a zero bound on their interest rates were not. Several policy implications follow for countries with a zero bound on their interest rates amid COVID-19.

Turkish Housing Market Dynamics: An Estimated DSGE Model

In this article, we investigate the underlying driving dynamics behind house price variations in Turkey by estimating a dynamic stochastic general equilibrium (DSGE) model in which the housing market and collateral constraints are included. The model also analyses the interaction between macroeconomic variables and the housing market by making policy simulations under different loan-to-value (LTV) ratios, which are used as a housing market-specific economic policy tool. The model is extended by including the traditional Taylor rule with house prices for representing monetary policy. Our findings show that house prices in Turkey are largely explained by housing preference shocks. Besides, we find that monetary policy shock plays a small role in determining the variables of the housing market in the short-term period. However, the magnitude of the impact of housing market shocks on the rest of the economy depends on the LTV ratios. The higher the LTV ratio, the higher are the effects of the government’s housing policy instrument for stabilising the housing market on real macroeconomic variables such as consumption and output in Turkey. Finally, our findings show that the fluctuations in house prices have not played a substantial role in the monetary policy reaction function of Turkey. JEL Codes: E32, E52, E44, E51, R31

Impact of Capital Movements on Sterilization and Monetary Policies in Pakistan: Evidence from Multiple Specifications

This paper aims at evaluating the effectiveness of central bank of Pakistan’s sterilization policy to neutralize the impact of capital movements on domestic monetary conditions. We also estimate how the sterilization efforts are frustrated/offset by fresh capital inflows. Sterilization coefficient and offset coefficients are estimated through Monetary Policy Reaction Function and Capital Flow Equation respectively. To check robustness of our results, we apply three different econometric techniques including Vector Error Correction Method, Two Staged Least Squares and Generalized Method of Moments. Using monthly data, we use one full sample: from 1982M1 to 2018M12 and two subsamples: i.e. from 1982M1 to 2001M09 and from 2001M10 to 2018M12. The results from the two equations from all specifications show that sterilization coefficients are relatively smaller than the offset coefficients implying that it is difficult for Pakistan to sterilize the impact of foreign capital inflows on domestic money base. Larger offset coefficients, on the other hand, particularly for the second subsample, indicate that Pakistan cannot conduct independent monetary policy under the free float exchange rate regime adopted in 2000. Our results from both equations are robust to all specifications and for all samples and subsamples. Major implication of our finding is that Pakistan cannot conduct independent monetary policy in after resorting to free float exchange rate regime.

Credit frictions, fiscal imbalances, monetary policy autonomy, and monetary policy rules

The current study mathematically derives the monetary policy reaction function (MPRF) by incorporating credit spreads, fiscal imbalances, and monetary policy autonomy. The policy reaction function (PRF) has been derived in the framework of Dynamic Stochastic General Equilibrium (DSGE) model. The model clearly states that capital controls allow the central authorities to focus on the stability of domestic prices instead of worrying about capital outflows. The results of the calibrated model predict that credit spread, fiscal imbalances, and monetary policy autonomy significantly affect the rate of interest. The estimates suggest that most of the variability in output, inflation, and the interest rate occurs due to supply and credit spread shocks.

Preduzete mere izabranih zemalja za očuvanje finansijskog tržišta

The global economic crisis occurred in 2008. The causes of the crisis are related to the economy of the United States. The crisis found its foothold within this economy, but it quickly spread its effects to the whole world. The crisis affected primarily the banking sector, given that the policy of low interest rates was in force at the time. The world economic crisis has left visible consequences in the Republic of Serbia. The beginning of the crisis in this area is related to 2008. After a decade of stabilizing the financial system, the whole world is once again facing a crisis of global proportions. The reason for this crisis lies in the epidemic of the coronavirus. The research in the paper established that the National Bank of Serbia also decided to apply unconventional measures, primarily quantitative reliefs and so-called helicopter money dropping program. The results of the measures can be presented through the analysis of the value of the monetary aggregates of selected countries. The fact is that the economic crisis that occurred after the health crisis caused by the coronavirus pandemic requires a quick reaction of monetary and fiscal policy, which was indisputably followed by analyzing a group of selected countries.

Optimal Robust Monetary Policy with Parameters and Output Gap Uncertainty

This paper studies optimal robust monetary policy when the central bank imperfectly observes potential output and has Knightian uncertainty about the intertemporal elasticity of substitution and the slope of the Phillips curve. The literature on optimal robust monetary policy has focused on either imperfect observability of some variables or on parameter uncertainty. We characterize robust monetary policy analytically under the two types of uncertainty and show that in general they call for a more aggressive reaction of monetary policy compared with the certainty case.

Monetary Policy Reaction Function for India

Monetary Policy Reaction Function for India