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Cost Channel of Monetary Policy: Financial Frictions and External Shocks
Authors:Jui-Chuan Della Chang  Chen-Jui Huang  I-Che Chien
Affiliation:1. National Chiayi University, Chiayi City, Taiwan;2. Tunghai University, Taichung, Taiwan;3. National Chengchi University, Taipei, Taiwan
Abstract:This paper deepens our understanding of the importance of the cost channel of monetary policy, where inflation adjusts with a firm's marginal cost of working capital. A model extended for a small, open economy with financial frictions is proposed and examined with data from Taiwan. The cost channel effect on inflation adjustment is substantiated by simultaneous generalized method of moments estimations and appears to be strengthened by financial frictions but mitigated by external shocks. Greater caution is hence required in the conduct of monetary policy for a bank-dependent emerging economy such as Taiwan because of the relative complexity in its supply-side interest rate pass-through.
Keywords:cost channel  external shock  financial friction  monetary policy
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