Monetary policy over the lifecycle

The thesis is composed of three chapters which analyze the monetary and macro-prudential policy using a New Keynesian DSGE model with the banking sector. The first chapter evaluates the effectiveness of time-varying macro-prudential tools and their interaction with monetary policy using the model framework of Gertler and Karadi (2011) which emphasizes the role of bank capital and endogenous leverage constraint due to the moral hazard problem. We consider the following three types of countercyclical macro-prudential tools: (i) capital requirements (CAR), (ii) deposit-based reserve requirements (DBRR), and (iii) asset-based reserve requirements (ABRR). The main findings are as follows. First, all three types of macro-prudential policy tools reacting to the financial condition (credit to output gap) are effective to mitigate the fluctuation of credit and business cycle by weakening the pro-cyclicality of banks' net worth and the counter-cyclicality of the endogenous leverage and external finance premium. Second, the effectiveness of each instrument differs by the source of shocks to the economy. In response to a TFP shock, the counter-cyclical CAR is the most effective to mitigate the fluctuation of credit and output and the ABRR is relatively more effective in response to capital quality shocks (credit supply shock). Third, all types of macro-prudential tools are welfare improving in combination with monetary policy, but the use of macro-prudential policy is relevant in response to the credit supply shock (financial shock). Finally, when the economy is hit by a financial shock, a relatively direct tool like asset-based reserve requirement (ABRR) can be the most welfare-improving and the relationship between monetary and macro-prudential policy can be complementary each other. The second chapter examines the role of banks' endogenous reserves and capital and the usefulness of financial condition (credit aggregates and external finance premium) as an indicator for setting up a relevant monetary policy rule. For the task, I construct an extended version of Goodfriend and McCallum (2007) model which is characterized by banks' loan production function with inputs (collaterals, monitoring works and bank capital buffer) under the households' deposit in advance (DIA) constraint. Main findings are as follows. First, banks' endogenous reserves can mitigate the variation of external finance premium by substituting costly monitoring works for lending. However, the effect of endogenous reserves on output and credits depends on types of shocks (credit-demand vs credit-supply shock), which reflects the role of external finance premium (EFP) as a banking attenuator (pro-cyclical EFP) or financial accelerator (counter-cyclical EFP) respectively. Second, the effect of banks' endogenous reserves can be limited when banks can adjust their capital flexibly compared to when banks' keep their capital to asset ratio (leverage) stable. Third, considering the role of money and the frictions on the credit-supply side, monetary policy reacting actively to the financial condition is welfare improving. These results imply that quantitative easing (QE) policy during the crisis was effective but the effectiveness of QE can be limited when banks can lower their leverage in a pro-cyclical manner. And monetary policy should pay more attention to the financial condition and prevailing interest rates as well as inflation and output gap in the presence of substantive financial frictions on the credit supply side in particular when the banking shocks dominate the economy. In the last chapter (co-authored with Professor Jagjit S. Chadha), we investigate the question facing many emerging economies: the extent to which a workhorse advanced economy model can yield important insights for monetary policy-making. We note that the standard sticky-price, monopolistically competitive model does not allow analysis of money and credit dynamics and led to a concentration of research on simple interest rate reaction functions. However, time-varying financial frictions tend to act as a tax on intermediation activities and so can vary output in a significant manner. In this chapter, we consider the implications of financial frictions for baseline monetary policy using a model calibrated on Indian data and find that a simple interest rate reaction function may not be welfare maximizing when banking shocks are dominant in the economy.

The recession following the sub-prime crisis has rekindled international interest in the field of monetary and fiscal policy interaction. However, very little has been done to appropriately estimate these dynamic policies. This paper estimates regime- switching monetary and fiscal policy rules and lays strong emphasis on mis-specification testing. We apply a Markov regime-switching model to estimate monetary and fiscal policy rules for India to highlight the evolving stance of Indian macro-policy for the period 1951–2008 and investigate the behaviour of select macroeconomic variables under the estimated policy regimes. Our results suggest that, in India, fiscal policy was largely active for the entire period except for a few periods of restraint. Monetary policy, despite achieving greater autonomy post-1990s, has largely been accommodating fiscal policy. Whenever monetary policy became active, fiscal policy undermined monetary policy’s effectiveness by not accommodating accordingly. We argue for an aggressive monetary policy and a constrained fiscal policy in India.

Interaction between monetary and macroprudential policies

Regime Switching Monetary and Fiscal Policy Rules and Interaction there-in: An Indian Case Study

This paper investigated the effect of bank size on the relationship between monetary policy and capital adequacy of listed deposit money banks in Nigeria for the period of 2015-2024. The thirteen 13 listed Deposit Money Banks (DMBs) on the Nigerian Exchange (NGX) out of the twenty-four 24 licensed (DMBs) were used for this study. Specifically, the study adopted multiple regression techniques as a tool of analysis and data were collected from secondary source through the Central Bank of Nigeria statistical bulletins; annual reports and account of the sampled banks. Capital adequacy is proxied by the Capital Adequacy Ratio (CAR), while monetary policy is measured using the Monetary Policy Rate (MPR) and Cash Reserve Ratio (CRR). Bank size is captured as the natural logarithm of total assets, and interaction terms are employed to test the moderating effect of bank size. The findings reveal that contractionary monetary policy exerts a negative and statistically significant effect on banks' capital adequacy, indicating that higher policy rates and reserve requirements weaken banks' ability to sustain regulatory capital buffers. The findings further show that bank size has a positive and significant influence on capital adequacy, with larger banks maintaining stronger capital positions than smaller banks. In addition, the interaction results demonstrate that bank size significantly moderates the relationship between monetary policy and capital adequacy, such that the adverse effects of monetary tightening are less pronounced for larger banks. The study concludes that the impact of monetary policy on bank capital adequacy in Nigeria is heterogeneous and strongly conditioned by bank size. These findings underscore the need for size-sensitive monetary and prudential policy frameworks that balance macroeconomic stabilization objectives with banking sector resilience. Keywords: Bank size, Monetary policy, Capital adequacy, Deposit money banks; Nigeria

This study empirically analysed the effect of monetary policy on inflation in Nigeria; 1970 – 2018. The objective is to determine the effectiveness of monetary policy instruments on inflation in Nigeria. In doing this, relevant literature was reviewed and theoretical relationship between monetary policy and inflation was established following the quantity theory of money by Irving Fisher. The study employed time series data sourced from the statistical bulletin of Central bank of Nigeria (CBN) 2018. Stationarity test was also conducted on the time series data to determine the order of integration using Augmented Dickey Fuller (ADF) test. The unit root test revealed that inflation rate was stationary at level i.e. I(0) while monetary policy rate, treasury bill rate and cash reserve ratio were stationary at first difference i.e. I(1). The estimated results showed that there is cointegration between monetary policy variables and inflation rate in Nigeria. The results revealed that Monetary Policy Rate (MPR) was statistically significant in the short run after first difference, which indicates that monetary policy rate (MPR) exerts significant effect on inflation in Nigeria in the short run. Based on these findings, the study concluded that monetary policy variables alone are not sufficient enough in maintaining price stability in Nigeria. Therefore, the Federal government, Central Bank of Nigeria (CBN) and policy makers should simultaneously use monetary and fiscal policy instruments to maintain price stability in Nigeria.

This study examines the impact of monetary and fiscal policy shocks on Romania, a former communist economy transitioning toward a functional market system. The research employs a structural vector auto regression (SVAR) model that integrates both fiscal and monetary policy variables, extending previous models by incorporating the short-term interbank interest rate as a key monetary policy indicator. The findings indicate that monetary policy plays a crucial role in controlling inflation in the medium term, while fiscal policy shocks - represented by government expenditure and revenue changes - exert marginal effects on macroeconomic indicators. Additionally, fiscal policy decisions influence monetary policy responses, prompting immediate central bank actions. These insights are particularly relevant in the current economic landscape, marked by geopolitical instability and inflationary pressures. The study contributes to the ongoing discourse on policy coordination in emerging economies, emphasizing the necessity of a balanced policy mix for macroeconomic stability.

The article analyzes the effectiveness of the NBU's monetary policy. During the period of independence, the National Bank never performed any of the functions stipulated by law. The main instruments of monetary and credit policy at the disposal of the central bank are not used as intended, and therefore do not ensure the performance of the functions entrusted to the National Bank of Ukraine, in particular: they do not ensure the stability of the hryvnia exchange rate, price stability, accelerated socio-economic development of the state and the adopted inflation level. The monetary and credit policy of the National Bank must be radically changed to ensure the implementation provisions of Art. 6 of the Law of Ukraine ‘On the National Bank of Ukraine'. The central bank's efforts must be coordinated with the government's efforts, and the central bank's monetary policy must be coordinated with the government's fiscal policy. In the paper, we propose to change the monetary policy instruments of the NBU in order to direct it to the support of the real sector of the economy and the stability of the exchange rate. The proposed changes provide for the establishment of refinancing rates up to 2%, placement of deposit certificates -2% (minus 2%). At the same time, it is necessary to make changes to the Tax Code of Ukraine regarding the introduction of progressive floating rates of taxation of the profit of financial institutions, limitation of the right to deduct losses from the tax base of financial institutions in certain cases. . . For the actual production of goods with a high added value, provide the reduction of the tax base for the part invested in production, and set the tax rate for the distributed part of the profit at the level of the personal income tax rate. Non- traditional methods of stimulating development are also proposed, in particular the purchase of government securities. The marginal value of government debt securities should be limited to 2-3% of GDP.

The pre‐crisis low‐interest‐rate environment is raising concerns among researchers and policymakers about its impact on the triangle prudential policy‐monetary policy‐bank's risk‐taking. While interest rates are set at low level for inflationary and economic growth reasons, they may lead banks to take more risk, jeopardizing the financial system and impeding the recovery. This paper provides a literature review, on the one hand, on the interaction of monetary and prudential policies through their impacts on bank's risk‐taking, and on the other hand, on the issues of their coordination. Monetary policy appears to have ambiguous effects on banks’ profitability, and then, on banks’ risk‐taking behavior. Despite monetary and prudential policies pursue different objectives, they inevitably interact, raising challenges that face policymakers. Albeit it is argued that monetary policy alone is not sufficient to maintain macroeconomic and financial stability, and that it should be coordinated with prudential policy, the form of this coordination is not clear‐cut.

know there's the myth of the autonomous Fed ... Nixon barked a quick laugh. --Richard Nixon, talking to Arthur Burns on October 23, 1969, just after Burns's nomination to the Fed had been announced. (1) I'd like to see another lowering of interest rates. I think there's room to do that. I can understand people worrying about inflation. But I don't think that's the big problem now. --George H. W. Bush, interview with New York Times, June 24, 1992. I. INTRODUCTION Economic conditions before elections affect election outcomes. (2) Rational politicians who recognize this regularity may, therefore, be tempted to try to influence the economy in the quarters preceding an election date to maximize their chances of being reelected. The literature on political business cycles (PBC) has developed models that rationalize economic fluctuations induced by political cycles. Nordhaus (1975) presented a model of political cycles: the party in power stimulates the economy before elections to improve its reelection probability. Others have observed that different parties may have different preferences over inflation and output or unemployment outcomes and, therefore, we should observe political cycles. Hibbs (1977) was the first to introduce the partisan cycle model, in which left-wing parties were assumed to have at least one of the following: a higher output target, a higher inflation target, or a higher relative weight on minimizing output rather than inflation deviations from the targets, compared with right-wing parties. Several papers test for the existence of opportunistic or partisan cycles in the United States. Alesina, Cohen, and Roubini (1992) and Alesina, Roubini, and Cohen (1997) find only weak evidence of an opportunistic political cycle looking at M1 growth rates. Grier (1989) and Beck (1987), instead, find support for the effect of political variables on M1 growth rates for the 1960-1980 period, but not on the mean level of the federal funds rate. As discussed in Drazen (2000a, 2000b), there is basically no evidence, instead, that political cycles matter for macroeconomic outcomes by looking at data on unemployment and output growth (Grier 2008 is a recent exception), and only weak evidence for inflation. Empirical tests of the partisan cycle model (Alesina, Roubini, and Cohen 1997; Faust and Irons 1999) find partisan differences in output growth rates, but no support for partisan cycles in inflation and monetary policy. Tests of PBC typically assume monetary policy as the main tool that is exploited by politicians to manipulate the economy. These studies usually focus on comparing the level of inflation, output, money growth rates, or interest rates across political cycles, or they add a political dummy variable to the relevant regression and test its significance. This paper offers a different approach. The paper aims to empirically test various political business cycle theories adopting an optimizing New Keynesian model with a monetary and fiscal policy mix as the main setting (the inclusion of both fiscal and monetary policy is motivated by Drazen 2000b). (3) The New Keynesian model is a baseline setting for the analysis of monetary policy, but it has not been widely used to study PBC. An advantage of this paper with respect to most of the previous PBC literature lies in the use of a general equilibrium framework: this is, in fact, necessary when testing the importance of politically motivated policy choices to effectively control for differences in the macroeconomic conditions, the set of shocks, or the private sector expectations that prevail when the policy decision is taken. The monetary and fiscal policy rule parameters, as well as the parameters that reflect the frequency of price adjustment by firms and the steady-state level of inflation, are allowed to depend on the (observed) political regime. …

Introduction.- Monetary Policy: Recent Theory and Practice.- Central Bank Design: Game Theoretic Analysis of Monetary Policy Institutions Outline of Two Controversial Positions on Central Bank Autonomy.- Monetary Policies: Strategies and Implementation: Theoretical Considerations on Strategies in Monetary Policy Conceptual Problems of Monetary Policy.- Theoretical Aspects of Exchange Rate Policy and Monetary Union: Problems of Flexible and Fixed Exchange Rates Approaching European Monetary Union: On Conversion Rates.- Monetary and Exchange Rate Policy in Developing and Transition Countries: Selected Issues: Some Explanation on Recent Currency Crises Monetary System Design: On Currency Boards.- Conclusion and Supplements.

Purpose The main purpose of this study is to see the macroeconomic effects of monetary and fiscal policy shocks in South Africa. Design/methodology/approach The joint effects of monetary and fiscal policy are analyzed by applying short-run contemporaneous restrictions for the identification of shocks in an SVAR in order to derive impulse response functions. Hence, a general AB model of (Amisano and Giannini, 1997) identification scheme, which is not recursive, is employed in this study. Findings The author shows that monetary tightening leads to a fall in real economic activity and depreciates the exchange rate. And in regard to the fiscal policy, the author calculates an initial government spending multiplier of 0.20, which later peaks at 0.40. The tax multiplier is almost 0 on impact and statistically insignificant. However, the author finds evidence supporting the existence of accommodative stance between monetary policy and fiscal policy, which is important for economic and political decision-making. Originality/value Empirical studies that deal with the joint effects of monetary and fiscal policy for South Africa through the SVAR framework are quite limited. This paper, therefore, contributes to the empirical literature on the effects of monetary and fiscal policy in a small open economy like South Africa.

How to quantitatively measure the macro dynamic effect of monetary policy is one of the most critical issues in the mainstream macro research （Benanke and Gertler, 1995; Christiano, et al., 1999）. In the context of global financial integration, how will a country’s monetary policy affect the macroeconomy of other countries? This international spillover effect of monetary policy has been hotly debated in the academy, but it has not yet been conclusive. The reason is that, empirically, how to identify the impact of exogenous monetary policy has not been well resolved at the technical level; theoretically, mainstream macroeconomic models provide various transmission mechanisms, and no consensus has been reached.Due to the above difficulties, research on the international spillover effect of monetary policy is still in its early stage, and the impact of US monetary policy on China’s economy is seldom studied. From the empirical point of view, this article follows the latest literature Barakchian and Crowe （2013, hereinafter referred to as BC） to identify the impact of exogenous monetary policy in the United States, and studies the dynamic impact of US monetary policy on China’s macroeconomy and its underlying transmission mechanism. This article provides new evidence on the international spillover effect of monetary policy and also tests the existing theories in international economics from an empirical perspective.The primary issue to be addressed in monetary policy research is how to identify exogenous monetary policy shocks. However, macroeconomic regulation often relies on the current situation of aggregate economy. Since there is a strong endogenous relationship among economic variables, it is difficult to directly construct a system that includes policy variables and macroeconomic indicators to identify exogenous monetary policy shocks. To this end, BC （2013） solves the endogenous issue regarding the identification of monetary policy shocks. The exogenous shock constructed through their indicator not only avoids making ad hoc assumptions about the feedback rules of monetary policy, but also avoids the endogenous problems and the sample selection issue in traditional identification methods.Based on the US monetary policy shock constructed by BC （2013）, this article studies the spillover effect of US monetary policy on China’s macroeconomy and therefore solves the aforementioned endogenous problem of monetary policy shocks. The basic model of the empirical analysis is a three-variable structural vector autoregressive error correction model （SVECM） that includes China’s industrial output, price index, and US monetary policy shocks. Based on this model, we find that the opening-up policy of WTO accession at the end of 2001 has a significant structural impact on the spillover effect of US monetary policy and its transmission mechanism. Specifically, we divide the monthly data from 1996−2008 into two sub-samples before and after January 2002. Using the 2002−2008 subsample, we find that the impact of the US’s tightening monetary policy significantly causes China’s output to rise and prices to fall, thus performing as a positive supply shock to China’s economy. Based on the 1996−2001 subsample, US monetary policy will not have a significant impact on China’s economy. The above findings are largely different from the findings in Kim （1999, 2001）, Canova （2005）, and among others.In the analysis of the transmission mechanism, this article finds that the price channel can well explain the stylized facts in the data. Our theory proceeds as follows: The US tightening monetary policy will lead to the appreciation of the US dollar, which will cause US manufacturers to lower their export prices in US dollars （Exchange Rate Pass-Through）. Due to the yuan-dollar fixed exchange rate system, China’s import prices will decline, and the prices of domestic raw materials and CPI will decline. Lower production costs lead manufacturers to increase production, which is reflected by an increase in China’s output. Therefore, the price channel indicates that the US tightening monetary policy is equivalent to a positive supply shock, which will simultaneously increase China’s output and reduce the price level. Based on the extended SVECM system, we find that Chinese macro data can identify the price channels of imported goods. Further robustness analysis shows that our main findings are robust to different sample periods and different model settings. Besides, in order to better explain the identification of import price channels, we have conducted empirical tests on several standard theories in international economics. The results show that the standard theories fail to explain the Chinese data. Therefore, the price channel provides the primary transmission mechanism of the spillover effect of US monetary policy on China’s economy, and this channel also explains the empirical finding that WTO has a structural impact on the spillover effect.

PurposeThe idea of this study is to provide a solid Financial Condition Index (FCI) that allows the monetary transmission policy to be monitored in a country which in recent decades has suffered from major financial and monetary crises.Design/methodology/approachThe authors construct three FCIs for Mexico to analyse the role of financial asset prices in formulating monetary policy under an inflation-targeting regime. Using monthly data from 1995 to 2017, the authors estimate FCIs with two different methodologies and build the index by taking into account the mechanism of transmission of monetary policy and incorporating the most relevant financial variables.FindingsThis study’s results show that, likewise for developing countries as Mexico, an FCI could be a useful tool for managing monetary policy in reducing macroeconomic fluctuations.Originality/valueApart from building a predictor of possible financial stress, the authors construct an FCI for a central bank that pursues inflation targeting and to analyse the role of financial asset prices in formulating monetary policy.HighlightsWe construct three FCIs for Mexico to analyse the role of financial asset prices in formulating monetary policy under an inflation-targeting regime.The FCIs are based on (1) a vector autoregression model (VAR); (2) an autoregressive distributed lag model (ARDL) and (3) a factor-augmented vector autoregression model (FAVAR).FCI could become a new target for monetary policy within a hybrid inflation-targeting framework.FCI could be a good tool for managing monetary policy in developing countries with a low-inflation environment.

This paper develops a calibrated dynamic stochastic general equilibrium model incorporating a banking sector and some unique features of China’s macroeconomic policies to simulate China’s monetary and macroprudential policies. The quantitative results show, first, that the interest rate is a better instrument for China’s monetary policy than the required reserve ratio (RRR) when the central bank is solely concerned about price stability; second, that the loan-to-value ratio is a very useful macroprudential tool for China’s financial stability, and the RRR could be used as an instrument for both objectives; third, monetary and macroprudential policies could be either complements or substitutes in China, depending on the choices of instruments for the two policies. Our policy experiments recommend three combination choices of instruments for China’s monetary and macroprudential policies. (JEL codes: E52, E61and G18)