VAR-Ing Monetary Policy in Poland

We use a dynamic general-equilibrium optimizing two-country model to analyze how the formation of exchange rate expectations shapes the effects of a monetary policy shock in an open economy. We also provide empirical evidence on how traders in foreign exchange markets form exchange rate expectations. Our model implies that the short-run output effect of a permanent monetary policy shock diminishes if “technical traders” form the type of regressive exchange rate expectations we find in our empirical analysis. If the influence of technical traders is strong enough, a permanent expansionary monetary policy shock can result in a temporary decline of the output in the country in which it takes place. The output effect of a temporary monetary policy shock is magnified when technical traders form regressive exchange rate expectations.

ABSTRACTThis study investigates the asymmetric effects of monetary policy shocks on the macroeconomic variables of exchange rate, output and inflation for an emerging economy ‒ Turkey ‒ by using monthly data between 1990 and 2014. We employ the innovative nonlinear vector autoregressive model of Kilian and Vigfusson (2011), which allows us to observe the effect of different stances (tight or loose) and different sizes (small or large) of monetary policy actions. Our empirical evidence reveals that tight monetary policy, which, in this case, is captured with a positive shock to interest rate, decreases exchange rate, output and prices, as economic theory suggests. Loose monetary policy, which is captured with a negative shock to interest rate, has the opposite effect on these variables. However, the effects of loose monetary policy are weaker than the effects of tight monetary policy because loose monetary policy shocks are less effective than tight monetary policy shocks. Moreover, as the magnitude of a shock increases, the difference between the effects of tight and loose monetary policy policies also increases.

Several studies have suggested that the prediction of standard theory on the effects of monetary policy on the exchange rate might not be applicable to or in the case of the Republic of Korea because participation of foreign investors is weak in the bond market but strong in the stock market. The current study examines the effects of monetary policy shocks on the exchange rate in the Republic of Korea by using structural vector autoregression models with sign restrictions. To determine the channels by which monetary policy shocks affect the exchange rate, I investigate the effects on various components of capital flows. The main empirical findings are as follows. First, a contractionary monetary policy shock, which increases the interest rate, appreciates the Korean won significantly in the short run as predicted by most theories. Second, contractionary monetary policy shocks increase capital inflows into the bond market consistent with the prediction of the uncovered interest parity condition. This seems to be the main channel by which contractionary monetary shocks appreciate the won. Finally, foreign investors tend to withdraw money from the domestic stock market in response to a monetary tightening, resulting in a decrease in capital inflows.

Sri Lanka’s monetary policy has evolved differently during and after a three-decade-long ethnic conflict. This paper empirically investigates effects of monetary policy shocks on Sri Lankan economy with particular focus on the strength of credit and exchange rate channels using a VAR model for 2003–2019 period. We find that: (i) monetary policy shocks have a significant and persistent impact on key macroeconomic variables even though several puzzling results emerge; (ii) the effects of monetary policy shocks are significant and more persistent in the post-conflict period than in the conflict period; (iii) a tight monetary policy effectively contains inflation in the post-conflict period; and (iv) interest rate and exchange rate channels play a dominant role while the credit channel responds with some lags in the post-conflict period.

Identifying monetary policy in a small open economy under flexible exchange rates

What are the effects of monetary policy on output? Results from an agnostic identification procedure

This article uses a structural VAR with daily data to identify the effects of monetary policy shocks on various longer term interest rates since the federal funds rate has been stuck at the zero lower bound. The VAR is identified using the assumption that monetary policy shocks are heteroskedastic: monetary policy shocks have especially high variance on days of FOMC meetings and certain speeches, while there is otherwise nothing unusual about these days. A complementary high-frequency event-study approach is also used. I find that stimulative monetary policy shocks lower Treasury and corporate bond yields but the effects die off fairly fast.

This paper studies the effect of wage rigidities on the transmission of fiscal and monetary policy shocks. We calculate downward wage rigidities across U.S. states using the Current Population Survey. These estimates are used to explain differences in the state-level economic effects of identical national shocks in interest rates and taxes. In line with the role of sticky wages in New Keynesian models, we find that contractionary monetary policy and tax shocks increase unemployment and decrease economic activity in rigid states considerably more than in flexible states. We also find larger and more persistent effects of monetary and tax policy shocks for states where the ratio between minimum and median wage is higher and for states that do not have right-to-work legislation.

The Impact of Monetary Policy Shocks on Commodity Prices

Measuring Monetary Policy Shocks in a Small Open Economy

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.

The Effectiveness of Monetary Policy in Steering Money Market Rates During the Financial Crisis

We examine the interaction of uncertainty and credit frictions in a New Keynesian framework. The model considers credit frictions arising from costly-state verification in the provision of loans to fund the acquisition of capital by entrepreneurs and includes three types of time-varying stochastic volatility shocks related to monetary policy uncertainty, financial risk (micro-uncertainty), and macro-uncertainty. Key parameters are estimated by the Simulated Method of Moments using U.S. data from 1984:Q1 until 2014:Q4. We find: 1. Micro-uncertainty has first-order effects that are significantly larger than the effects of macro-uncertainty and monetary policy uncertainty. 2. Poor credit conditions exacerbate the economic drag from micro-uncertainty shocks, amplify the effects of monetary policy shocks, and mitigate the impact of TFP shocks. 3. A degree of asymmetry and non-scalability appears in response to monetary policy shocks, dependent on the degree of nominal rigidities and initial conditions. 4. Monetary policy uncertainty accounts for about one-third of the business cycle volatility largely by affecting the size of monetary policy shocks.

Empirical modelling of the monetary policy effects using conventional linear econometric models is put to a great test when interest rates approach the zero-lower bound. A possible remedy recently proposed in the literature is to introduce a shadow short rate (SSR) obtained from the yield curve model as an alternative monetary policy measure. This paper examines the usefulness of shadow rates as a policy stance measure for the Euro area. Moreover, the SSR can be used to study the country-specific monetary policy stance. We incorporate the shadow short rate in a standard vector autoregressive analysis to study the effects of monetary policy shocks both at the level of the Euro area and for two periphery EA countries, Italy and Spain, that endured significant financial stress during the crisis. Our analysis shows that monetary policy shocks identified form the SSR produce similar macro responses as shocks identified from the standard policy rate. The Euro area shocks can directly translate to a corresponding change in the country-specific financing conditions in the periphery, whereas the reverse effect is limited. The historical decomposition of the stochastic component of the SSR series shows that the unconventional policy measures were effective in stabilising the sovereign crisis in 2011, however, their relatively limited quantity provided only a weak stimulus to the economy.

Recent research provides evidence of important changes in the U.S. economic environment over the last 40 years. This appears to be associated with an alteration of the monetary transmission mechanism. In this paper we investigate the implications for the evolution of monetary policy effectiveness. Using an identified VAR over the pre-and post-1980 periods we first provide evidence of a reduction in the effect of monetary policy shocks in the latter period. We then present and estimate a fully specified model that replicates well the dynamic response of output, inflation, and the federal funds rate to monetary policy shocks in both periods. Using the estimated structural model, we perform counterfactual experiments to determine the source of the observed change in the monetary transmission mechanism, as well as in the economy's response to supply and demand shocks. The main finding is that monetary policy has been more stabilizing in the recent past, as a result of both the way it has responded to shocks, but also by ruling out non-fundamental fluctuations.