MONETARY TRANSMISSION MECHANISM IN CENTRAL AND EASTERN EUROPE: SURVEYING THE SURVEYABLE

Abstract.  This paper surveys recent advances in empirical studies of the monetary transmission mechanism, with special attention to Central and Eastern Europe (CEE). Our results indicate that the strength of the exchange rate pass-through substantially declined over time mainly due to a fall in inflation rates and to some extent due to the so-called composition effect. The asset price channel is weak and is likely to remain weak because of shallow stock and private bond markets and because of low stock and bond holdings of domestic households. House prices may become an exception with booming mortgage lending and with high owner occupancy ratios. While the credit channel could be a powerful channel of monetary transmission – as new funds raised on capital markets are close to zero in CEE – it is actually not, as both commercial banks and non-financial corporations can escape domestic monetary conditions by borrowing from their foreign mother companies. The moderately good news, however, is that those banks and firms are influenced by monetary policy in the euro area because their parent institutions are themselves subjected to the credit channel in the euro area.     

Monetary policy in a small open economy with fixed exchange rate: The case of Macedonia

This paper empirically applies the New Keynesian model for monetary policy analysis in a small open economy with a fixed exchange rate. Official reserves are included in the interest rate rule to account for the constraint that these impose on monetary policy when the exchange rate is fixed. Also, the foreign interest rate is included in order to reflect the necessity of following the foreign monetary policy. The model is applied to Macedonian data from the period 1997 to 2011. In general, results indicate that monetary policy has been focused on domestic objectives during this period, despite the fixed currency. In addition, there seem to have been significant differences in the conduct of the monetary policy in the first and second half of this period. The response to inflation has been more aggressive in the earlier period, at a time when reserves appear less important, while the output gap is found to be important only in the latter period, possibly due to the stronger monetary policy transmission. Finally, results indicate that the monetary policy has likely moved from adaptive in the first period to rational in the second period.     

我国货币政策利率传导渠道的体制转换特征——利率市场化改革进程中的考察

本文考察了我国利率市场化改革进程中货币政策利率传导渠道效应的体制转换特征。实证结果表明:1978年第一季度至2009年第二季度期间我国货币政策传导的管制利率渠道发生了两次体制转换,转换之后贷款基准利率调整对产出和物价水平的效应都降低了。1996年1月至2009年7月期间我国货币政策传导市场利率渠道发生了一次体制转换,转换之后同业拆借利率变动平抑产出和物价波动的效果都更强劲、更持续。这意味着我国的利率市场化改革取得了阶段性成果,也意味着我国利率调控由直接方式逐渐转向主要依靠间接方式不仅是必要的,也是可行的。     

In search for yield? Survey-based evidence on bank risk taking

Monetary policy can have an impact on economic and financial stability through the risk taking of banks. Falling interest rates might induce investment into risky activities. This paper provides evidence on the link between monetary policy and bank risk taking. We use a factor-augmented vector autoregressive model (FAVAR) for the US for the period 1997–2008. Besides standard macroeconomic indicators, we include factors summarizing information provided in the Federal Reserve’s Survey of Terms of Business Lending (STBL). These data provide information on banks׳ new loans as well as interest rates for different loan risk categories and different banking groups. We identify a risk-taking channel of monetary policy by distinguishing responses to monetary policy shocks across different types of banks and different loan risk categories. Following an expansionary monetary policy shock, small domestic banks increase their exposure to risk. Large domestic banks do not change their risk exposure. Foreign banks take on more risk only in the mid-2000s, when interest rates were ‘too low for too long’.     

How does the money market development impact the bank lending channel of emerging Countries? A case from China

Transforming from quantitative-based instruments to price-based instruments is the primary goal of the monetary policy transformation in emerging economies. In essence, this process is gradually replacing the interest rate channel with the credit channel from the perspective of the monetary policy transmission mechanism, which is mainly achieved by promoting financial development to reduce the financial friction. However, there are opposite effects of financial development on the bank lending channel; thus, the topic is controversial. Using banks’ data from 2010 to 2018, this paper studies whether and how the money market development weakens the effect of the bank lending channel in China. The result shows that the mechanism through which the money market development influences the bank lending channel is realized by affecting the substitution elasticity of the asset and liability structure of banks’ balance sheets. Different from the theoretical expectation, the effect of the money market development on the bank lending channel is nonsignificant in China but appears to be weakened when the interest rate market-oriented reform is considered. However, further research based on structural analysis demonstrates that the money market development exerts heterogeneous effects on the bank lending channel under different types of sub-markets and different characteristics of the banks considered.     

Managed Floating as a Monetary Policy Strategy

Although there seems to be a broad consensus among economists that purely floating or completely fixed exchange rates (the so-called corner solutions) are the only viable alternatives of exchange rate management, many countries do not behave according to this paradigm and adopt a strategy within the broad spectrum of exchange rate regimes that is limited by the two corner solutions. Many of these intermediate regimes are characterized by significant foreign exchange market interventions and a certain degree of exchange rate flexibility with non-preannounced exchange rate targets. While academic research in this area usually concentrates on some specific aspects of intermediate regimes (such as the effectiveness of interventions or institutional aspects), managed floating has rarely been analyzed as a comprehensive monetary policy strategy. In this paper, we present a monetary policy framework in which central banks simultaneously use the exchange rate and the interest rate as operating targets of monetary policy. We explain the mechanics of foreign exchange market interventions and sterilization and we explain why a central bank has an interest of controlling simultaneously the two operating targets. We derive the monetary policy rules for the two operating targets from a simple open economy macro model in which the uncovered interest parity condition and the monetary conditions index play a central role.     

Monetary policy in open economies: Practical perspectives for pragmatic central bankers

This paper reviews and interprets some of the key policy implications that flow from a class of DSGE models for optimal monetary policy in the open economy. The framework suggests that good macroeconomic outcomes in open economies are possible by focusing inflation targeting that is implemented by a Taylor type rule, a rule that in equilibrium is reflected in the exchange rate as an asset price. Optimal monetary policy will not be able deliver a stationary (‘stable’) nominal exchange rate – let alone a fixed exchange rate or one that remains inside a target zone – because, absent a commitment device, optimal monetary can’t deliver a stationary domestic price level. Another feature in the data for inflation targeting countries that is consistent with monetary policy via Taylor type rule is that it will tend push the nominal exchange rate in the opposite direction from PPP in response to an ‘inflation’ shock—the ‘bad news god news’ result of Clarida and Waldman (2008. Is Bad News about Inflation Good News for the Exchange Rate. In: John Campbell, (Ed.), Asset Prices and Monetary Policy, Chicago: University of Chicago Press), Clarida and Waldman (2014. Bad News About Inflation is Good News for the Nominal Exchange Rate Under Optimal Monetary Policy: DSGE Theory and a Decade of Empirical Evidence). This is so even though in the long run of these models the nominal exchange rate must in expectation obey PPP.     

Does trade integration alter monetary policy transmission?

This paper explores the role of trade integration—or openness—for monetary policy transmission in a medium-scale new Keynesian model. Allowing for strategic complementarities in price setting, we highlight a new dimension of the exchange rate channel by which monetary policy directly impacts domestic inflation: a monetary contraction which appreciates the exchange rate lowers the local currency price of imported goods; this, in turn, induces domestic producers to lower their prices too. We pin down key parameters of the model by matching impulse responses obtained from a vector autoregression on time series for the US relative to the euro area. Our estimation procedure yields plausible parameter values and suggests a strong role for strategic complementarities. Counterfactual simulations show that openness alters monetary transmission significantly. While the contractionary effect of a monetary policy shock on inflation and output tends to increase in openness, we find that monetary policy's control over inflation increases, as the output decline which is necessary to bring about a given reduction of inflation is smaller in more open economies.     

The Conduct of Monetary Policy Without Monetary Aggregates

A central dilemma for the monetary authorities is how to determine monetary policy. The increasing unreliability of monetary aggregates has led over the past few years to less concern for monetary targeting, both in the UK and elsewhere, and a greater influence for the exchange rate on monetary policy. But in the UK, most recently, there has been a move away from setting monetary policy in relation to the exchange rate and external considerations in favour of setting monetary policy in relation to domestic demand. Not surprisingly, this shift has occurred at a time of rising concern about domestic overheating. It illustrates the dilemma of whether monetary policy should be driven by domestic demand considerations or by external, exchange rate considerations. This dilemma is not just confined to the UK for it is a real source of conflict underlying the Louvre Accord and its successors that seek to determine G7 exchange rates in a cooperative manner. In what follows, we argue that exchange rate developments should have an appreciable influence on monetary policy, since this is helpful in attaining stable inflation. But we also suggest that this influence should not go too far, since this stability of inflation may be at the expense of stability of domestic demand and output. Targeting of exchange rates within narrow bands is unlikely to be desirable, unless fiscal policy can be used more flexibly to stabilize domestic demand. This suggests that, in the period up to the spring, the use of monetary policy to hold the £/JDM exchange rate within narrow limits may have been overdone. More seriously, international exchange rate agreements among the G7 countries are likely to founder under adverse market pressures, unless current imbalances in fiscal policy are adjusted. In the absence of greater flexibility in fiscal policy, policy makers will have to trade off domestic and exchange rate considerations in determining monetary policy. An important outstanding issue that needs further consideration is what indicators should be used for monetary policy, in a world in which monetary aggregates provide unreliable signals.     

Monetary policy and bank performance: The role of business models

This paper examines the relationship between monetary policy and bank performance in a multiple-instrument environment, particularly highlighting the conditioning role of bank business models. Employing a unique dataset of Vietnamese commercial banks from 2007 to 2019, we display that banks react to monetary policy changes, either when the central bank increases policy rates or injects money into the economy through open market operations, by decreasing overall returns and increasing financial instability. Additionally, we document that the accumulation of foreign exchange reserves benefits bank outcomes, contrasting to open market operations, albeit the central bank uses both of these policy instruments to alter money supply in the economy. Our key analysis of interest reveals that business models considerably matter in the effects of monetary policy on bank performance. Collectively, our findings demonstrate that banks’ business models that yield more non-interest income or diversify more into different income sources may mitigate the pass-through of monetary policy to bank performance. This finding holds across all interest- and quantitative-based monetary policy indicators and across all the functions of risk-taking behavior, earning-profit capacity, and financial stability. Furthermore, while plotting the marginal effects of monetary policy, we realize that they are insignificant for banks whose business models heavily rely on non-traditional segments.     

The effects of U.S. monetary policy on Colombia and Panama (2002–2007)

I study the economies of Colombia (floating exchange rate) and Panama (dollarized) to illustrate how the monetary policy of a large economy can export capital structure distortions to small open economies that follow different exchange rate regimes. The paper contributes to the literature on international business cycles in two ways. First, it adds to recent research that extends the Mises–Hayek business cycle theory to an international context. Second, most current research abstracts from effects on the production structures of emerging market economies when analyzing the transmission of monetary policy shocks. This paper seeks to fill this gap by studying structural effects of U.S. monetary policy on the economies of Colombia (floating exchange rate) and Panama (dollarized).     

The effects of monetary policy in Russia: A factor-augmented VAR approach

Using factor-augmented vector autoregressive (FAVAR) models, this study examines the effects of the Central Bank of Russia’s (CBR) monetary policy on economic indicators. The sample includes 39 monthly macroeconomic series and covers the period 2004 through 2019. The analysis revealed counter-intuitive results, with consumer prices often responding positively to a contractionary monetary policy shock, and vice versa; this is related to the impossible trinity. The ruble exchange devaluation was accompanied by price increases through an import price pass-through, so the CBR chose exchange stability and free capital flows out of the impossible trinity, temporarily subordinating monetary policy independence. Such independence was limited, possibly due to Russia’s high dependence on energy exports and the link between energy prices and the exchange rate. The findings indicate no direct evidence of an effect of monetary policy tightening on the decrease in consumer prices; rather, the attenuation of ruble depreciation may have helped to stabilize prices, even after the CBR adopted inflation targeting.     

Fear of floating or monetary policy as usual? A structural analysis of Mexico's monetary policy

This paper uses Bayesian methods to estimate a small open economy dynamic stochastic general equilibrium (DSGE) model for the period in Mexico after the 1994 crisis. I consider a Taylor rule as the expression of the evolution of monetary policy to gauge its response to the exchange rate in the post-crisis period. The estimation results favor a consistent response of the nominal interest rate to the short-run nominal exchange rate after 1994. Although fear of floating is present, Mexico's monetary policy has taken steps toward a credible free-floating exchange rate that targets inflation.     

An input–output model of exchange-rate pass-through

The impact of the exchange rate on price formation is often debated through a mechanism called the exchange-rate pass-through. Studies of the pass-through generally rely on econometric analysis implemented on time series data. This study examines pass-through to the domestic price level through an input–output model. The proposed model is implemented on a sample of countries, and a number of different variables connected to the pass-through are examined. A comparison across countries and sectors highlights the importance of the construction sector in price formation. National income is negatively related to the pass-through. A high dependence on intermediate imports implies higher pass-through. Price level volatility and pass-through are positively related; whereas a country’s monetary policy stance has no apparent effect. The effect of exchange-rate volatility is unclear; it is negative for the real effective exchange rate, the connection is very weak in the case of the nominal exchange rate.     

EXCHANGE RATE PASS-THROUGH

Abstract. The resilience of trade balances of the major industrialized economies to changes in their exchange rates has evoked interest in the exchange rate pass-through relationship. So far, there has not been a comprehensive survey of this literature. The paper aims to fill this gap in two ways. First, it pieces together the theoretical literature on exchange rate pass-through. Second, it provides a critical survey of the empirical literature on exchange rate pass-through. Emphasis is placed on the data and methodology employed in previous work. This is done in order to guide future work in this growing area of research.     

资本管制有效性与中国汇率制度改革

本文在利率平价框架下考察了近十年中国资本管制的效力。我们采用比较类似金融工具在国内外市场的收益率、检验未抛补利率平价理论偏差的平稳性两种方法进行分析。研究表明,尽管资本管制的效力随时间推移有所下降,但境内外美元利差的持续存在以及未抛补利率平价理论偏差的非平稳性仍然足以证明中国的资本管制基本有效。资本管制的有效性在盯住制框架下确保了汇率稳定和一定的货币政策自主性,并且使未来汇率制度弹性化改革可以渐进地推进。     

INTEREST RATE PASS‐THROUGH: A META‐ANALYSIS OF THE LITERATURE

The interest rate pass‐through describes how changes in a reference rate (the monetary policy, money market or T‐bill rate) transmit to bank lending rates. We review the empirical literature on the interest rate pass‐through and systematize it by means of meta‐analysis and meta‐regressions. Using the pass‐through to corporate lending rates as the baseline, we find systematically lower estimated pass‐through coefficients in studies that focus on the pass‐through to consumer lending rates and rates on long‐term loans. Also studies estimating the pass‐through by averaging all lending rates into one category report a lower pass‐through. Importantly, the interest rate pass‐through is significantly influenced by the country's macro‐financial environment. In economies with deepening stock markets, the estimated pass‐through strengthens significantly. Interestingly, after the global financial crisis, the pass‐through weakened across the board, including because of growing trade openness and supply chain financing, rising volatility and stock market turnovers, as well as declining central bank independence. Inflation targeting frameworks, if in place, helped diminish this pass‐through weakening.     

How does Monetary Policy Respond to Exchange Rate Movements? New International Evidence*

This article analyzes how monetary policy has responded to exchange rate movements in six open economies, paying particular attention to the two‐way interaction between monetary policy and the exchange rate. We address this issue using a structural VAR model that is identified using a combination of sign and short‐term (zero) restrictions. Doing so we find that, while there is a instantaneous reaction in the exchange rate following a monetary policy shock in all countries, monetary policy responds significantly on impact to an exchange rate shock in only four of the six countries.     

The bank lending channel of monetary transmission in Brazil: A VECM approach

This paper tests for the existence of a lending channel in the transmission of monetary policy in Brazil using aggregate monthly data for the period 1995:12 through 2008:6. The test is carried out in a VECM setting that allows for multiple cointegrating relationships among the variable of interest. We find evidence of two cointegrating vectors, which we identify as loan demand and supply functions by testing for a number of exclusion and exogeneity restrictions on the cointegrating relationships. Loan supply is found to be negatively related to the interbank deposit certificate rate, suggesting the existence of a lending channel for monetary transmission. The VECM's short-term dynamics show that loan demand is equilibrium-correcting. But short-term disequilibria in the supply of loans are corrected through changes in the interbank deposit certificate rate, suggesting that monetary policy plays a role in restoring equilibrium in the credit market by affecting the borrowing rate faced by banks to raise non-deposit funds.     

Monetary policy rules for convergence to the Euro

This paper investigates the applicability of open-economy convergence-consistent instrument rules for monetary policies in the economies undergoing monetary convergence to a common currency area. The proposed policy rule is forward-looking, consistent with a monetary framework based on inflation-targeting containing input variables that are relative to the corresponding variables in the common currency area. Robust forms of the policy rule are tested empirically for three inflation-targeting countries converging to the euro, i.e. the Czech Republic, Poland and Hungary. Empirical tests imply systemic differences in monetary policies among these euro-candidates. The Czech monetary policy seemingly follows the rule prescribed by our model. Both the Czech and the Polish central bank interest rate policies respond predominantly to changes in the inflation gap, while the Hungarian responds mainly to the exchange rate gap. In all three cases, changes in the eurozone short-term interest rates strongly drive adjustments in the central banks’ reference interest rates.