The role of exchange rate in inflation targeting: the case of Turkey

ABSTRACT

The role of the exchange rates in emerging market economies that have adopted inflation targeting (IT) is a critical and contentious issue in the relevant literature. This article investigates whether an exchange rate-augmented Taylor rule describes the Central Bank of Republic of Turkey’s (CBRT) monetary policy. Covering the period from 2002:1 to 2017:8 it also explores possible nonlinearities in the reaction function of the CBRT by employing a Threshold Vector Autoregressive (TVAR) model. The linear estimation of the model highlighted the importance of the exchange rate in monetary policy under IT. The results of the nonlinear model indicate that the stance of monetary policy was asymmetric with respect to exchange rate movements during the conventional IT period. However, the asymmetric monetary policy stance disappeared in the aftermath of the Global Financial Crisis. Increasing considerations of financial stability undermined the asymmetric policy stance of the CBRT in the post-crisis period.     

THE INSTABILITY IN THE MONETARY POLICY REACTION FUNCTION AND THE ESTIMATION OF MONETARY POLICY SHOCKS

We extend Romer and Romer's (2004) analysis of the estimation and the effects of monetary policy shocks by controlling for (1) changes in the monetary policy reaction function and (2) changes in the response of output and prices over time with an extended data set. The results suggest that the post 1979 responses of output and prices to a monetary policy shock are significantly different from what has been reported for the whole sample: While output and prices respond significantly and negatively if their response is estimated for the whole sample period (1969–2005), the response of output is insignificant for the period of 1979–2005, and the response of prices is much weaker. The analysis of the changes in the monetary policy conducted over time allows us to partly attribute the diminished price and output responses to a successful monetary policy which led to a less volatile economy during the great moderation. (JEL E52, E32, C50)     

Monetary Regime Choice and Optimal Credit Rationing at the Official Rate: The Case of Russia

ABSTRACT

Stabilizing monetary policy in a small open economy is constrained by the open economy trilemma. In this paper, we investigate whether foreign exchange market interventions and the Central Bank’s credit rationing at the official rate (CROR) may soften this constraint and improve the results of monetary policy for different monetary regimes. We construct a dynamic stochastic general equilibrium (DSGE) model appropriate for analyzing the forward-looking behavior of households facing non-zero probabilities of losing access to financial market and CROR. We have found significant credit rationing in the quarterly Russian data of 2001:Q1–2014:Q2. The probability of losing access to financial market and the probability of CROR are estimated as 22% and 66%, respectively. Using Russian data of 2001:Q1–2014:Q2 we demonstrate that CROR provoked forward-looking activity in financial market, which led to more Ruble devaluation in the crises of 2008–2009. It improved poor countercyclical performance of two Russian monetary policy rules, whereas made small effect on welfare. Welfare maximization exercises reveal a tradeoff between low-inflation and high-welfare solutions and favor of a floating exchange rate regime. We found the optimal value of the probability of CROR in both exchange rate-based and Taylor rule-based models but resulting improvement in welfare is very small.     

Comparing monetary policy reaction functions: ECB versus Bundesbank

This paper compares the European Central Bank’s (ECB) conduct of monetary policy with that of the Bundesbank. Estimated monetary policy reaction functions show that the ECB reacts similarly to expected inflation but significantly stronger to the output gap than the Bundesbank did. Theoretical considerations suggest that this stronger response to the output gap may rather be due to a higher interest rate sensitivity of the German output gap than to a higher weight given to output stabilisation in the objective function of the ECB. Counterfactual simulations based on the estimated interest rate reaction functions reveal that German interest rates would not have been lower under a hypothetical Bundesbank regime after 1999. However, this conclusion crucially depends on the assumption of an unchanged long-run real interest rate for the EMU period and is reversed when the Bundesbank reaction function is adjusted for the lower long-run real interest rate estimated for the ECB regime.

Does the Reserve Bank of Australia follow a forward-looking nonlinear monetary policy rule?

ABSTRACT

The conventional monetary policy rule describes a simple linear relationship between the domestic interest rate, inflation rate and output gap. An important extension to this rule is to incorporate the forward-looking behaviour of central banks, where it is assumed that they target an expected level of inflation instead of its current realised value. Using quarterly observations for the period 1993:1-2018:2, this paper investigates whether the conduct of monetary policy in Australia can be described by a forward-looking linear monetary policy rule, or by a nonlinear forward-looking monetary policy rule. In particular, the nonlinear forward-looking monetary policy rule is analysed in a regime-switching framework using a smooth logistic transition regression model. While the results show that the conventional forward-looking linear monetary policy rule describes the application of monetary policy in Australia reasonably well, the interest rate setting behaviour of the RBA is best described by a nonlinear forward-looking monetary policy rule.     

Contemporary Monetary Policy in China: An Empirical Assessment

This paper focuses on monetary policy in China. A set of different specifications for the monetary policy reaction function are empirically evaluated using monthly data for 1998–2014. Overall, the performance of the estimated policy rules is surprisingly good. Chinese monetary policy displays countercyclical reactions to inflation and leaning‐against‐the‐wind behaviour. The paper shows a notable increase in the overall responsiveness of Chinese monetary policy over the course of the estimation period. The central bank interest rate is unresponsive to economic conditions during the earlier years of the sample, but response becomes significant in later years. This finding comports with the view that the monetary policy of the People's Bank of China has come to place greater weight on price‐based instruments. A time‐varying estimation procedure suggests that the two monetary policy objectives are generally assigned to different instruments. The money supply instrument continues to be utilized to control the price level. Since 2008, the interest rate instrument has been mainly used to achieve the targeted output growth.     

Monetary Policy Regime Shifts and Uncovered Interest Parity Revisited: The Euro–US Dollar Exchange Rate

ABSTRACT

To explore possible sources of the well-documented uncovered interest parity (UIP) violation in the foreign exchange market, this paper scrutinizes structural changes in monetary reactions to inflationary pressure in the conventional approaches to nominal exchange rate and examines how this small but important change has an effect on the empirical implications of the UIP condition. In addition to some salient features found in the euro exchange rate, by introducing occasional monetary policy regime shifts into an otherwise standard open-economy dynamic general equilibrium model, we found some important findings that potentially help better understand exchange rate dynamics. During the entire sample period, 1999:M1–2014:M8, exchange rate disconnect puzzle still exists. However, sub-sample analysis suggests that relatively passive monetary reaction implying less frequent intervention by monetary authority tends to be more consistent with the UIP relation. Simulation results support the empirical regularities.     

Why Economists should Choose their Inheritance: Physics and Path-independence in Economic Systems

Abstract

This paper considers the possibility of using fiscal rather than monetary policy as the instrument of stabilization policy in a new consensus framework. Describing the conduct of fiscal policy in terms of a ‘pseudo Taylor rule’, it is shown that fiscal policy is as, if not more, effective than monetary policy as a tool for macroeconomic stabilization. The conclusion reached is that the comparative neglect of fiscal policy as an instrument of stabilization policy in new consensus macroeconomics is unwarranted.     

The effects of economic policy uncertainty on China’s economy: evidence from time-varying parameter FAVAR

ABSTRACT

This article explores the effects of China’s economic policy uncertainty (EPU) on its fiscal policy, monetary policy and a wide range of macro-economic variables using a time-varying parameter FAVAR model. Based on monthly data from 07/2003 to 08/2017, the time-varying structure of the model allows us to capture the time-varying characteristics of the macro-economic variables and which channel is relevant. Empirical results reveal that the reaction of monetary and fiscal policies to EPU is highly asymmetric across macro-economic circumstances. Loose monetary and fiscal policies are adopted in response to EPU shocks during the financial crisis, while policies are moderately tightened after the crisis. The China Interbank Offered Rate (Chibor) responds more sensitively and severely than M2 to EPU shocks. Additionally, EPU shocks have a significant and negative impact on economic growth, consumption, exchange rates, bonds and the stock market, but showing a positive impact on credit, real estate and fixed asset investment (which might be due to China’s special economic market environment and the high investment return). The results indicate that EPU shocks significantly affect macroeconomic fundamentals through precautionary savings and financial market channels but lose their effectiveness through a ‘real options’ effect.     

Alternative Monetary Targets,Instruments and Future Monetary Policy Frameworks

ABSTRACT

This article expands on the debate of whether merely controlling inflation can be considered a good outcome in terms of monetary policy, discussing proposals for adopting alternative monetary targets (e.g., price level, nominal GDP), alternative instruments (e.g., monetary finance, central bank digital currencies), for enlarging central banks' mandates (e.g., incorporating employment, wages, inequality, environmental objectives) and for the design of future monetary policy frameworks.

We argue that in the coming years, central banks should not simply maintain their pre-2008 standards by de-implementing unconventional monetary policies. Instead, they must take advantage of their past and recent experiences in order to improve, under an evolutionary perspective, future monetary policy and financial stability frameworks. Based on this, measures implemented since the 2008 crisis would have three possible treatments in new frameworks: i) be discarded, due to their predominantly adverse effects; ii) not be regularly implemented, but be used as backstop mechanisms if needed; iii) be incorporated as regular measures of monetary policy/financial stability frameworks. Accordingly, monetary and financial stability authorities will increasingly need to evolve and engage in a continuously adaptive and innovative process in order to face challenges posed by financial markets that are becoming more dynamic, innovative, complex, interconnected and globalised.     

The Political Economy of Monetary Institutions in Brazil: The Limits of the Inflation-targeting Strategy, 1999–2005

Abstract

This paper suggests that the time-inconsistency approach is inadequate to analyze the political economy of monetary policy in Brazil. The paper develops an alternative theory that emphasizes distributive conflict, and argues that building credibility with a fixed exchange rate and through inflation-targeting was not central for stabilization. A contested-terrain analysis of the Brazilian case suggests that the current monetary regime benefits financial or rentier interests while the manufacturing sector and workers bear the costs of this policy.     

The impact of (un)conventional expansionary monetary policy on income inequality – lessons from Japan

ABSTRACT

This paper analyzes the impact of conventional and unconventional monetary policy on income inequality in Japan, using hitherto unexplored data from the Japan Household Panel Survey. Empirical evidence shows that expansionary monetary policy in Japan has contributed to diminishing the gender pay gap through an increase in working time of women relative to men, but also to increasing the education pay gap. These effects may have materialized via the aggregate demand channel and the labour productivity channel. In contrast, expansionary monetary policy has had no significant impact on the development of the age pay gap.     

How do central banks react to wealth composition and asset prices?

We assess the response of monetary policy to developments in asset markets in the euro area, the US and the UK. We estimate the reaction of monetary policy to wealth composition and asset prices using: (i) a linear framework based on a fully simultaneous system approach in a Bayesian environment; and (ii) a nonlinear specification that relies on a smooth transition regression model.     

A Macro-Level Account of Money and Credit to Explain Gendered Financialization

ABSTRACT

The paper intervenes in the debate on macroeconomics, money, gender, and financialization. Generally, there is an omission in gender studies on gender-specific effects of monetary policy. Not only is there a blind-spot about the role of monetary policy in feminist political economy, there is equally a blind-spot in meso-level analysis which focus on the social construction of institutional mechanisms and the predatory market power of oligopolistic banks. Yet, monetary policy is neither neutral in the short-term nor long-term. Such policies have gender-differentiated effects on employment, income, consumption, savings which in turn have feed-back effects on economic growth. My intent is to focus on the changing role of monetary policy and highlight the omission in gender studies on financialization, as well as argue that the shift of the credit cycle to fictitious capital (future revenue) is one of the central explanatory variables in the predatory banking model of subprime lending. Yet, the financial crisis of 2007 did not usher in a normalisation of the credit and finance system. Exactly the opposite happened. Unconventional monetary policy continues to facilitate a credit system based on future claims which has gendered distributional effects, in the process increasing the wealth inequality on a global scale.     

Should a central bank react to food inflation? Evidence from an estimated model for Chile

We examine whether food price shocks are a major source of macroeconomic fluctuations. We estimate a small open economy DSGE model using an alternative Taylor rule applied to Chilean data. The empirical evidence suggests that food inflation played a non-trivial role in shaping Chile's de facto monetary policy actions. Consistent with its commitment to price stability, the central bank increases the policy rate in reaction to food inflation. Despite an immediate monetary policy reaction to a food price shock, the policy rate gradually tapers off. This is due to a second-round effect on non-food inflation propagated by the food price shock. A main finding is that monetary policy that targets headline inflation is welfare improving.     

Openness and the Effectiveness of Monetary Policy: A Cross-country Analysis

Abstract

This paper evaluates the relationship between a country's openness to trade and the effectiveness of monetary policy in changing output growth and inflation in 29 different countries. Using quarterly data from the 1957–2003 period, empirical estimates based on individual country specifications show that the direction, significance and nature of the relationship between openness and the effectiveness of monetary policy on output growth as well as inflation vary considerably across countries.     

Post-crisis business investment in the euro area and the role of monetary policy

ABSTRACT

Business investment in the euro area strongly declined during the Global Financial Crisis and the Sovereign Debt Crisis. It has not yet rebounded to its pre-crisis trend despite the very expansionary monetary policy measures of the ECB. We analyse the sluggish recovery in business investment in the euro area and the role of monetary policy in three steps. We investigate the main factors that have impeded business investment since the Global Financial Crisis. We empirically analyse how business investment has developed compared to typical patterns during other financial crises. Based on these results, we then discuss how effective monetary policy has been in stimulating business investment since the Global Financial Crisis. We conclude that business investment in the euro area has developed broadly in line with typical post-crisis patterns. Monetary policy significantly contributed to stabilize business investment at the beginning of the crises. In the aftermath of the crises, however, there seems to be little scope for monetary policy to further stimulate investment.     

The liberalization of trade and foreign direct investment: a political economy analysis

Abstract

In theory, the IMF could influence fiscal and monetary policy via several channels, among them advice to policy makers, conditionality, and the moral hazard it induces with the borrowers. This article tries to disentangle those effects empirically. Using panel data for 98 countries over the period 1975–2000 it analyzes whether IMF involvement indeed influences fiscal and monetary policy in program countries. There is evidence that participation in IMF Standby and Extended Fund Facility arrangements improves economic policy. Money disbursed and the degree to which a program is implemented does not have any systematic influence. The same is true for future availability of resources as measured by exhaustion of a country’s quota with the Fund. The final section discusses policy implications.     

Revisiting the Coyne Affair: a singular event that changed the course of Canadian monetary history

Abstract The Coyne Affair occurred during the 1959–61 period and led to the resignation of the governor. Eventually major reforms of the Bank of Canada Act were enacted. Archival and empirical evidence is used to assess the performance of monetary policy throughout the 1950s. In doing so, a real‐time data set is constructed for both Canada and the US that permits the estimation of a reaction function. I find that while the case against James Coyne is ‘not proven,’ there was a brief period when monetary policy was excessively tight, and this may well have worsened an already weak economic environment.