Costly Tax Enforcement and Financial Repression

Using an overlapping generations production‐economy model characterized by financial repression, purposeful government expenditures and cost of tax collection, we analyse whether financial repression can be explained by the cost of raising taxes. We show that with public expenditures affecting utility of the agents, modest costs of tax collection tend to result in financial repression being pursued as an optimal policy by the consolidated government. However, when public expenditures are purposeless, the above result only holds for relatively higher costs of tax collection. But, more importantly, costs of tax collection cannot produce a monotonic increase in the reserve requirements. What are critical, in this regard, are the weights the consumer assigns to the public good in the utility function and the size of the government.     

Financial market imperfections and monetary policy strategy

In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank applying the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if interest rate pass-through is incomplete, the central bank can use a narrow monetary aggregate and the discount interest rate as independent and complementary policy instruments to reinforce the credibility of its announcements and the role of inflation target as a nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman's k-percent money growth rule, which can generate dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.     

The role of the financial system in the growth–inflation link: the OECD experience

This paper jointly estimates the effects of financial development and inflation on growth using both cross-section and time-series dimensions of the data on inflation, growth, and some banking and stock market indicators over the period 1961–1993 for a sample of OECD countries. Overall, the results indicate, first, that the long-run costs of inflation are not explained by policies of financial repression and, second, that if inflation affects growth through its interaction with financial market conditions, this is not the only (nor the most important) channel.     

Optimal targeted reduction in reserve requirement ratio in China

This study determines the optimal targeted reduction in reserve requirement ratio in China. We find that a targeted reduction in reserve requirement ratio incentivizes commercial banks to reallocate more credit resources to micro and small enterprises, thus eliminating the negative output gap, slightly dampening the rise in unemployment, but also increasing financial instability. Although there is little direct effect on inflation, raising the targeted reduction in reserve requirement ratio can help mitigate the positive effect of output gap on inflation so that an output gap increase is accompanied by a smaller increase in inflation. Optimal rules for targeted reduction in reserve requirement ratio and interest rate policy are derived. Output gap, inflation, and financial instability are three main factors driving the policy dynamics. A targeted reduction in reserve requirement ratio is complementary to interest rate policy, which helps eliminate the negative output gap and allows the interest rate to be less responsive to inflation volatility.     

Inflation and public debt reversals in advanced economies

This paper quantitatively assesses the effects of inflation shocks on the public debt-to-GDP ratio in 19 advanced economies using simulation and estimation approaches. The simulations suggest that 1 percentage point shock to the inflation rate can reduce the debt-to-GDP ratio by about 0.7 percentage points on average across countries, while the estimated impulse responses are a little larger and more persistent. Additional assumptions taking into account financial repression do not necessarily make these effects substantially larger. These results imply that modestly higher inflation, even if accompanied by some financial repression, could reduce the public debt burden only marginally.     

An Endogenous Growth Model of a Financially Repressed Small Open Economy

The paper develops a monetary endogenous growth model of a financially repressed small open economy, characterized by curb markets, capital mobility, transaction costs in domestic and foreign capital markets, and a flexible exchange rate system, to analyze the impact of financial liberalization – interest rate deregulation and lower multiple reserve requirements – on growth and inflation. When the model is calibrated to match world figures, we find that interest rate deregulation enhances growth and reduces inflation in steady-state. For relatively smaller transaction costs in the curb market, the above result is, however, reversed. Under such circumstances, lowering the transaction costs in the foreign capital market tends to restore the growth-enhancing (inflation-reducing) capabilities of interest rate deregulation. Lower reserve requirements, though, always ensures lower (higher) steady-state inflation (growth).     

Asset-based Reserve Requirements: Some Reservations

Abstract

Thomas Palley's (2004) paper ‘Asset-based reserve requirements: reasserting domestic monetary control in an era of financial innovation and instability’ has radical implications for monetary policy and the operations of central banks in the money markets. This comment argues that Palley's proposal may be impractical today because it overlooks banks' holding of excessive reserves (or claims on such reserves), and because reserves allocated for particular kinds of business cannot be isolated in bank balance sheets or markets. In particular, once differential reserves are imposed on particular kinds of business, banks may respond to changes in reserve requirements by varying their assets in less predictable ways than the scheme suggests. A central bank's willingness to use differential reserve requirements will be inhibited by the current policy doctrine that emphasises control of a stable money market rate of interest. In any case, it is doubtful if interest rates or reserve requirements could have the specific targeted effects that Palley's model suggests.     

中国的“三元悖论”政策目标组合选择及其影响

本文构建了"三元悖论"政策目标指数,并探讨了中国的宏观经济管理策略对经济稳定性的影响。研究发现,中国以汇率高度稳定作为首要目标,并追求适度的货币政策独立性,而谨慎追求金融开放,并积累了巨额外汇储备。这种策略的影响包括:(1)较高的货币政策独立性对降低产出波动率有积极作用,因持有外汇储备的间接影响使得汇率高度稳定政策也显著降低了产出波动率,金融开放同样也起到了降低产出波动率的作用;(2)积累巨额外汇储备与追求汇率高度稳定政策间的交互影响使得汇率稳定成为维持物价稳定的消极因素,货币政策独立性将降低国内通货膨胀波动率而积累过多的外汇储备却恶化这种影响,金融开放将增加物价波动性。文章凸显出过度追求人民币名义汇率稳定的弊端。     

Macroeconomic Control in the Transforming Chinese Economy: An Analysis of the Long‐Run Effect

This paper analyzes the issue of macroeconomic control in the Chinese economy where there is a dual structure (consisting of a state sector and a non‐state sector) and the financial sector is still under tight control by the government. Given the dual structure and financial repression, when inflation is a severe problem, the authors investigate whether it is possible for the government to bring inflation under control without hampering long‐term economic growth performance. The investigation is conducted within the context of an endogenous growth model that incorporates the two major institutional features of the transforming Chinese economy. The paper evaluates the long‐run effects of changes in government monetary and fiscal policies on the major macroeconomic aggregates. The analysis suggests that increasing in the interest rate on government bonds will reduce inflation without affecting the growth rate of output; while increasing the nominal interest rate on bank deposits will exert a stagflationary effect on the economy: raising the inflation rate but reducing the growth rate of output.     

Dollarization and the inflation threshold

Abstract.  Empirical evidence suggests non-linearity in the impact of inflation on financial intermediation and real activity. Evidence also suggests that high inflation affects financial intermediation through the substitution of dollars 'under the mattress' for savings in domestic banks. We model an economy where inflation and real activity are positively related at low levels of inflation. However, when the inflation rate exceeds a threshold, agents substitute dollars for deposits issued by domestic banks, reducing the scale of financial intermediation and investment. As a consequence, at high levels of inflation, capital stock and output become negatively related to the inflation rate.     

The negative side of inflation targeting: revisiting inflation uncertainty in the EMU

ABSTRACT

This article tests the Friedman–Ball hypothesis for the European Monetary Union (EMU) countries, using a GARCH methodology. The empirical results show a positive relationship between inflation and inflation uncertainty, largely supportive of the Friedman–Ball hypothesis. Furthermore, the ECB’s price stability mandate is found to have asymmetric, if not limited, effects on inflation uncertainty since 1999, with the findings different for the so-called peripheral countries when compared to the core. For the majority of the EMU countries, shifts away from the 2% target served to increase inflation uncertainty. The credibility of the ECB since the financial crisis, in attempting to meet its 2% inflation target has seen inflation uncertainty increase for some, likely driven by inflation failing to re-anchor. Furthermore, recent periods of deflation are found to generate inflation uncertainty, with short-term price variability increasing in line with observed negative price growth for the majority of the EMU countries. The results are supportive of a U-shaped relationship between inflation and inflation uncertainty. Using spline techniques, we formally provide support for such a U-shaped relation where inflation uncertainty broadly increases below a certain threshold for each country’s inflation rate. Asymmetric effects across countries are found in the level of this threshold.     

Beliefs about Exchange‐Rate Stability: Survey Evidence from the Currency Board in Bulgaria

Abstract

Currency pegs seldom achieve full credibility even after delivering low inflation and a stable exchange rate for many years. We use unique survey data from Bulgaria’s currency board to investigate the origins of incomplete credibility. We show that the limitations imposed by the currency board on output stabilization policies are a major source of concern. Many people view the financial stabilization policies as a reason for high unemployment and therefore as unsustainable. Another important factor for low credibility is the concern over potential international shocks. Conversely, past instability does not seem to translate strongly into expectations of future instability.     

An augmented P-star model of Indian inflation

ABSTRACT

An augmented P-Star model is estimated and tested to identify the drivers of inflation in India. The model includes monetary and non-monetary factors, demand-pull and cost-push factors, and domestic as well as foreign factors. The results show that inflation in India is driven by a combination of monetary factors and non-monetary factors, some of which affect inflation on the supply side while others operate on the demand side. It turns out, however, that inflation in India is determined more by domestic rather than foreign factors.     

Financial liberalization and the stationarity of money multiplier

Abstract

In countries without an explicit inflation targeting mechanism, a stable relationship between the monetary base and the money supply allows policymakers to implement changes in monetary policy with a reasonable degree of certainty about the impact on the money supply. The relationship can, however, be influenced by major structural shifts such as financial sector reforms. The present study finds that when structural change bought about by financial liberalisation is ignored, the unit root hypothesis is spuriously accepted. However, once this break is incorporated into the analysis, the multiplier exhibits no presence of a stochastic trend.     

Time Series Analysis of Inflation Targeting in Selected Countries

Abstract

We analyze a set of countries which adopted inflation targeting (IT) as a policy tool. We model the pre‐IT period with ARMA and GARCH methods, and conduct the one‐step ahead forecasting for the remainder of the times series data. The actual and forecasted inflation levels are compared for each country. We find that even though the actual inflation levels are lower than the forecasted ones, there is no statistical evidence to suggest that the adoption of IT causes a structural break in the inflation levels of the countries which adopt IT.     

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.     

Channels of financial market contagion

This study aims to fill a gap in the current literature by determining which channels of financial contagion are the most significant in transmitting crises between countries. Initial results, using χ² contingency tables, indicate that there is a significant relationship between contagion and the inflation rate and between contagion and financial liquidity. A simultaneous comparison of the channels is then performed using a series of best subset logit regressions. These suggest that a combination of high inflation and an emerging market classification form the most significant subset in increasing the probability of a contagious event.     

Keynes‐Marx and Keynes‐Wicksell Models of Monetary Growth: A framework for future analysis

This paper reconsiders and generalizes a dichotomizing two-sector real growth model of Marglin which claims that the steady state of capitalist economies is plagued by secular inflation. We show that this implication need not be true from the perspective of a more general steady state analysis and that the Marglin model can be embedded into a general Keynes‐Marx‐Friedman or Keynes‐Wicksell framework where money is superneutral, where therefore inflation is due solely to excessive monetary growth, where the private sector is basically asymptotically stable and where there is a steady state rate of employment that differs from the 'natural' rate of employment of monetarist models of inflation. We consider this model a benchmark model that requires equally general alternatives if the above implications are to be rejected.     

Inflation,Unemployment and Hysteresis: An alternative view

This paper integrates ideas concerning the influence of the interest rate on the rate of profits with an analysis of inflation and its relation with unemployment. Inflation is regarded, as in Kaleckian contributions, as resulting from inconsistent claims on income, but the approach taken leads to different conclusions concerning the effects of inflation (or deflation) on income distribution, and the circumstances giving rise to acceleration of inflation. The approach followed in the paper also provides explanations of phenomena that have appeared 'puzzling', particularly the association of different unemployment rates with stable inflation, and the persistence of high rates of unemployment.     

Evaluating inflation targeting as a monetary policy objective for India

This study formulates a small open economy model for India with exchange rate as a prominent channel of monetary policy. The model is estimated using the Instrumental Variable-Generalized Methods of Moments (IV-GMM) estimator and evaluated through simulations. This study compares different cases of domestic and CPI inflation targeting, strict and flexible inflation targeting, and simple Taylor type rules. The analysis highlights the unsuitability of simple Taylor-type monetary rules in stabilizing the Indian economy and suggests that discretionary optimization works better in stabilizing this economy. There seems to be a trade-off between output gap stabilization and exchange rate stabilization in flexible domestic inflation targeting and CPI inflation targeting respectively. However, flexible domestic inflation targeting seems a better alternative from an overall macro stabilization perspective in India where financial markets are still not sufficiently integrated to ensure quick transmission of interest rate impulses and existence of rigidities in the economy.