MONETARY POLICY AND ITS IMPACT ON ECONOMY
Authors Name – Nilesh Subhash Turankar
· Measuring monetary policy and its impact on the emerging economy.
Sensarma, Rudra and Bhattacharyya, Indranil. (2015)
This paper adopts a macro-finance approach in analysing the impact of monetary policy on the bond market yield curve of an emerging economy viz., India. In this regard, the paper contributes in an area which has, hitherto, received relatively less attention in the literature. The paper enriches the understanding of monetary policy and market dynamics of the bond market in India on two counts. First, it proposes and develops a summative measure of monetary policy to account for the multiple instruments employed by the central bank and uses it to assess the impact on the yield curve. Second, it examines the impact on the government yield curve, the corporate yield curve and the credit spread yield curve in terms of the latent factors using market proxies.
· Unconventional Monetary Policy in an Open Economy
Jana Gieck (2014)
In this paper, I examine two scenarios for each unconventional measure either only one central bank or both central banks introduce unconventional policies which I interpret as coordination and non-coordination in monetary policy. I find that if only one central bank injects liquidity into the interbank market, the exchange rate appreciates for 2 periods and depreciates thereafter. The appreciation in the first 2 periods is caused by the increase in credit supply which also hikes up prices and thus the exchange rate (which is defined by the terms of trade). As soon as credit supply starts to fall in the third period (although it is still above its steady state) prices also decline leading to a depreciation of the exchange rate. By contrast, asset swaps lead to a slight depreciation of the exchange rate in the first period and appreciate it thereafter. Asset swaps lead to a decrease in credit growth in the first period which also depresses prices, thus depreciating the exchange rate. After the first period, however, assets swaps increase credit supply together with prices leading to an appreciation in the long run. Another result of this paper is that coordinating unconventional policies is advisable in some cases but not in others, it mainly depends on the target of the central bank and the instrument it wishes to use. For instance, in the case of liquidity injections, the best outcome in terms of higher GDP is achieved with non-coordination. Then, however, the other country will be affected by negative spill overs which lead to declines in GDP. With regard to inflation, liquidity injections have the disadvantage that they increase inflation variation by the same amount under coordination and non-coordination. By contrast, asset swaps increase output and lower inflation variation the most only if coordinated. But even in the case of non-coordination, the spill overs coming from asset swaps are generally positive. While both measures are able to increase GDP, the impact of liquidity injections is substantially stronger than the impact of asset swaps. This is due to way both measures are modelled: liquidity injections create additional resources which banks can use to increase credit supply; asset swaps just change the quality of banks assets not the amount of assets. Thus the impact of asset swaps is less pronounced. For the same reason is variation in inflation substantially higher under liquidity injections than under assets swaps.
· Monetary Policy Uncertainty and its impact on the real economy
Quelhas, João (May 2022)
Uncertainty has gained much attention from economists in the last decade as it was, arguably, one of the main drivers of the depth and duration of the Great Recession (Bloom, 2014). The European Central Bank (ECB) reported that uncertainty in the Euro area rose substantially during the Great Recession and the Sovereign Debt Crisis, and that these high levels of uncertainty potentially dampened economic activity, notably investment (ECB, 2016). Recently, the European and the world economy have been affected by unprecedented episodes of uncertainty, as shown in Figure 1 by the World Uncertainty Index (WUI).
The most recent event was the Covid-19 pandemic when uncertainty rose to levels never seen before. The unknown consequences of the health crisis made economic agents less certain about their future and, as a result, important decisions have likely been postponed. As Blanchard states1, uncertainty leads to dramatic collapses in demand, freezing economic activity. To limit the consequences of the recession and prevent instability in the financial system, central banks promptly provided liquidity, limiting the impact of the economic breakdown. The quick decrease in the WUI, shown in the Figure 1, highlights the crucial role of policymakers in events of extreme uncertainty to mitigate that feeling and stabilize the economy
The contemporaneous occurrence of uncertainty spikes and sharp policy interventions restarted the debate on the impacts of uncertainty on the real economy and on the transmission of monetary policy shocks. Nevertheless, the empirical work on the impact that central banks may have in these events and on how uncertainty constrains the influence of their actions is still limited
· THE IMPACT OF MONETARY AND TAX POLICY ON INCOME INEQUALITY
Farhad Taghizadeh-Hesary, Naoyuki Yoshino, and Sayoko Shimizu (April 2018)
Growing inequality, especially in advanced economies has attracted much attention from policy makers and academics (Yellen 2014; Bernanke 2015; Draghi 2016). Equality is considered a significant value in most societies akin to fairness. Regardless of ideology, culture, and religion, individuals acknowledge inequality as unfavorable (Dabla-Norris et al. 2015). Not only can it become a cause for instability within society, studies have shown it can hinder economic growth. Recent empirical works found that high levels of inequality are harmful for the pace and sustainability of growth (Ostry, Berg, and Tsangarides 2014). Also, Cingano (2014) strengthened the finding by demonstrating through an econometric analysis on Organisation for Economic Co-operation and Development (OECD) countries and concluding that income inequality has a negative and statistically significant impact on subsequent growth. The analysis shows that the income distribution itself matters for gross domestic product (GDP) growth. Specifically, if the income share of the top 20% increases, then GDP growth declines over the medium term. In contrast, an increase in the income share of the bottom 20% is associated with higher GDP growth (DablaNorris et al. 2015). Others have argued that increasing inequality may have been a critical contributing factor to the global financial crisis (GFC henceforth). Rajan (2010) argues that increasing inequality led to political pressure for more housing credit, which intensified the falsified lending in the financial sector. Ranciere and Kumhof (2011) present that, in the United States, the Great Depression of 1929 and the GFC of 2008 were both anticipated by a rapid rise in income and wealth inequality and by a sharp rise in debt-to-income ratios among low-income households.
· MONETARY POLICY AND ITS IMPLICATIONS ON ECONOMIC GROWTH
Elena Violeta, Drăgoi1 Oana-Mihaela, Ilie
In the market economy, economic growth can be determined using economic and social policies developed and implemented. To stimulate economic growth an extended period, monetary policy acts by liquidity management on the money market, by increasing / decreasing interest rate of monetary policy and minimum reserve ratio and also by targeting the exchange rate. Through the implementation of monetary policy, resource allocation is achieved efficiently, that allows: achieving long-term investment plans; proper functioning of market mechanisms; discouraging the speculative actions; removing economic imbalances (inflation); saving resources to invest in productive activities. Next to monetary policy acts the fiscal policy using the system of taxes, public investment and social protection. A developed economy adopt structural policies, to ensure the functioning of market mechanisms by stimulating investment in certain sectors, but also by a restructuring of underperforming companies and reforming the labour market. So, the application of structural policies can reduce unemployment rate and increase workforce performance and quality of enterprises, helping the economy to function effectively. Regarding the economic growth on short and medium term as cyclical process, caused by periodic fluctuations, it`s clear that economic policies, especially monetary policy, act by adopting anti-cyclical behavior.Thus, in the expansion phase of economic cycle, characterized
By the emergence of inflationary pressures, it’s better to adopt a tight monetary policy, while in the recession phase of economic cycle, characterized by a lack of inflationary pressures generated by the existence of unused resources is beneficial simulative monetary policy implementation. However, the decision to adopt a monetary policy becomes difficult given that supply shocks are dominant, particular in emerging economies. The situation is different in developed economies, because in order to reduce the risk of deflation, monetary policy interest rates have been brought close to zero. Through monetary policy developed and applied by the central bank adopted an anticyclical behaviour before and after the outbreak of global financial crisis which aimed to maintain financial stability and ensuring an optimal framework for restoring economic equilibrium. Thus, in the period of economic expansion, the central bank acted significant upside reserve ratios and interest rate monetary policy, tightening credit conditions, defined as restrictive conduct. Moreover, during economic recession, the central bank resorted to significant reduction of monetary policy rate and reserve ratios designed to stimulate aggregate demand. A first step in the evolution of economic growth can be achieved by applying an economic policy mix, in various ranges, because no state are not used “pure” economic policy. Another way of intervention refers to stimulate aggregate demand in order to relaunch the economy. Regarding the role of monetary policy, it is focused on maximizing well-being, contributing to sustainable economic growth through price stability and currency. Given the tools at its disposal, monetary policy can determine the inflation level in economy, but cannot directly influence the level of GDP in long term. In order to determine inflation level in the Romanian economy NBR adopted an inflation targeting strategy, reducing its level comparative with the European one, despite some variations in trend.
· Impact of Monetary Policy on Industrial Growth
Owolabi A. Usman, Adegbite Tajudeen Adejare
Monetary policy has emerged as one of the most critical government responsibilities; monetary policy is seen as providing a flexible and powerful instrument for achieving medium-term stabilisation objectives, in that it can be adjusted quickly in response to macroeconomic developments (Philip 2010). Monetary Policy is associated with interest rate and availabilities of credit, the instruments used include short-term interest rates and bank reserves through the monetary base. There are two forms of monetary policy; Decision about coinage and Decision to print papers money in order to create credit. The interest rate as part of the monetary authority was not generally coordinated with the other forms of monetary policy. It was seen as an executive decision and was generally in the hands of the authority with power to coin. The ability to set the price could be enforced by law even if it’s different from the market price. The importance of price stability derives from the harmful effects of price volatility, which undermines the ability of policy makers to achieve other laudable macroeconomic objectives. With the achievement of price stability, the conditions in the financial market and institutions would create a high degree of confidence, such that the financial infrastructure of the industry is able to meet the requirements of market participants. Indeed, an unstable or crisis-ridden financial sector will render the transmission mechanism of monetary policy less effective, making the achievement and maintenance of strong macroeconomic fundamentals difficult. This is because it is only in a period of price stability that investors and consumers can interpret market signals correctly. Typically, in periods of high inflation, the horizon of the investor is very short, and resources are diverted from long-term investments to those with immediate returns and inflation hedges, including real estate and currency speculation. It is on this background that this study would investigate the effectiveness of the monetary policy in Nigeria with special focus on major growth components.
· Monetary policy and its impact on stock market liquidity
Octavio Fernandez-Amador, Martin G ´ achter, ¨ Martin Larch, Georg Peter (2011)
The liquidity of financial markets, defined as “the ease of trading” (Amihud et al., 2005), has attracted a lot of attention, as the recent financial crisis highlighted its role as a precondition for well-functioning and efficient markets. Although central banks all over the world tried to ease financial markets during the recent crisis period by means of massive monetary policy interventions, we know surprisingly little so far about the actual relationship of monetary policy on stock liquidity. Since Amihud & Mendelson (1986) suggested that stock returns are an increasing function of illiquidity, numerous successive studies investigated this relationship. Indeed, the empirical literature generally confirms the theoretical proposition that investors demand higher gross returns as compensation for holding less liquid stocks.1 Another well-established strand of the academic literature on asset liquidity documents that the liquidity of individual stocks exhibits significant co-movement, which is usually referred to as commonality in liquidity.2 Covariation in the liquidity of stocks implies that the illiquidity risk cannot be diversified and therefore illiquidity should be regarded as a systematic risk factor.3 Furthermore, the observed commonality suggests the assumption that there needs to be at least one common factor that simultaneously determines the liquidity of all stocks in a market, which might be monetary policy. The hypothesis we test in this paper is that the monetary policy of central banks is a common determinant of stock liquidity. In particular we examine the relationship between the European Central Bank’s (ECB) monetary policy interventions and stock liquidity. Anecdotal evidence suggests that the ECB itself seems to be well aware of the necessity to actively take care of market liquidity, since the ECB executive board member Jos´e Manuel Gonz´alez-P´aramo stated: “This environment poses challenges for central banks, as addressing funding liquidity shortages may require supporting market liquidity”.4 Indeed, our results indicate that an expansionary (contractionary) monetary policy leads to an increase (decrease) in the liquidity of stocks. We observe this relationship at the microeconomic level for individual stocks by applying panel estimations and at the macroeconomic level for aggregate liquidity by using vector autoregressive (VAR) models.
· Ensuring Financial Stability: Financial Structure and the Impact of Monetary Policy on Asset Prices
KATRIN ASSENMACHER-WESCHE STEFAN GERLACH(March 26, 2008)
There is much agreement that asset prices, in particular residential property prices, provide a crucial link through which adverse macroeconomic developments can cause financial instability.1 Episodes of asset price “booms” are seen as raising the risk of a sharp correction of prices, which could have immediate repercussions on the stability of financial institutions. Indeed, many observers have argued that propertyprice collapses have historically played an important role in episodes of financial instability at the level of individual financial institutions and the macro economy (e.g. Ahearne et al. 2005, Goodhart and Hofmann 2007a). Not surprisingly, this view has led to calls for central banks to react to movements in asset prices “over and beyond” what such changes imply for the path of aggregate demand and inflation (Borio and Lowe 2002, Cecchetti et al. 2000). Proponents of this policy emphasise that episodes of financial instability could depress inflation and economic activity below their desired levels. Consequently, they argue, central banks that seek to stabilise the economy over a sufficiently long time horizon may need to react to current asset price movements (Bean 2004, Ahearne et al. 2005). Importantly, they do not argue that asset prices should be targeted, only that central banks should be willing to tighten policy at the margin in order to slow down increases in asset prices that are viewed as being excessively rapid in order to reduce the likelihood of a future crash that could trigger financial instability and adverse macroeconomic outcomes. While seemingly attractive, this proposed policy has implications for central banks’ understanding of economic developments and for the effectiveness of monetary policy (Bean 2004, Bernanke 2002, Kohn 2006). First, central banks must be able to identify in real time whether asset prices are moving too fast or are out of line with fundamentals. Second, changes in policy-controlled interest rates must have stable and predictable effects on asset prices. Third, the effects of monetary policy on different asset prices, such as residential property and equity prices, must be about as rapid, since stabilising one may otherwise lead to greater volatility of the other. Needless to say, if these criteria are not satisfied simultaneously, any attempts by central banks to offset asset price movements may simply raise macroeconomic volatility, potentially increasing the risk of financial instability developing. Fourth, the size of interest rate movements required to mitigate asset price swings must not be so large as to cause economic activity and, in particular, inflation to deviate substantially from their desired levels since, if this were to be the case, the resulting macroeconomic cycles could lead the public to question the central bank’s commitment to price stability. Fifth, the effects of monetary policy on asset prices must be felt sufficiently rapidly so that a tightening of policy impacts on asset prices before any bubble would burst on its own (since policy should then presumably be relaxed to offset the macro economic effects of the collapse of the bubble).
· Fiscal and Monetary Policies in an Agent-Based Model
Pong pitch Amatyakul Nutnicha Theppornpitak(April 26, 2022)
In this paper, we leverage an agent-based model (ABM) to analyse the impacts of monetary and fiscal policies on the economy that has been adversely affected by a COVID-19-like shock. In an economy with a central bank constrained by the zero-lower-bound interest rate, traditional monetary policy may be insufficient to effectively stabilize the economy after a large negative shock. As we have seen in many countries during the COVID-19 pandemic, fiscal stimulus from the government is necessary to try to steer the economy back to their initial growth paths.
To induce a COVID-19-like scenario, we generate a negative shock to the economy by depressing future expectations of income. This decreases demand and results in negative GDP growth and lower inflation. The central bank responds by decreasing interest rates, but it is constrained by the zero-lower-bound, therefore, we allow the government to step in with fiscal policies. Three specific policies are analyzed: unconditional cash transfers to all citizens, conditional cash transfers to the poor, and subsidies for purchases of goods. The three policies are made to proxy three recent policies by Thai government. While not completely unconditional, the “We don’t leave anyone behind” (Thai: “Rao-mai-ting-kan”) policy reached over 15 million Thais affected by the pandemic ranging from temporary workers and farmers to small shop owners and entrepreneurs. On the other hand, the state welfare card program are more targeted, with strict income and asset requirements. The subsidy for the purchase of goods is based on the “Let’s Go Halves” (Thai: “Kon-lakrueng”) scheme where payments made to restaurants and small shop owners are subsidized by 50 percent by the government, with a cap of 150 THB per day.
To enable comparisons across scenarios, the fiscal policies are normalized such that the cost to the government are the same. The results are then analysed at the aggregate level with GDP, inflation, unemployment, and number of bankrupted firms. In addition, since we are introducing conditional cash transfers, it follows that we should scrutinize the distribution effects of the fiscal transfers. The distribution of consumption for all agents are compared across the different policy combinations.
The paper contain 5 subsequent sections. Section 2 gives a brief literature review. In section 3, we provide details on how the agents interact and describe key characteristics of 2 the model. Section 4 details specific events that happen in the simulation and the rules agents follow in order to make decisions. Section 5 contains results from the basic simulation, results from the COVID-19 shocks, and results from different policy combinations used to combat the initial shock. Finally, section 6 contains the conclusions.
· The impact of monetary policy on bond returns: A segmented markets approach
Bruce Mizrach, Filippo Occhino(22 June 2007)
This paper assesses the contribution of monetary policy to the dynamics of bond real returns. We assume that the monetary authority controls the short-term nominal interest rate. We then model exogenously the joint dynamics of the aggregate endowment and the monetary policy variable, and determine bond real returns endogenously. We adopt a heterogeneous agent’s variant of the limited participation framework, the segmented markets model, previously studied by Alvarez and Atkeson (1996), Alvarez, Lucas, and Weber (2001), Occhino (2004), and Lahiri, Singh, and Vegh (2007). The central feature is that a set of households are permanently excluded from financial markets. In the full participation version of the model, real returns are determined by the marginal utility of the representative household, and, therefore, by the aggregate consumption and endowment. Hence, monetary policy affects real returns through its effect on the aggregate endowment. When markets are segmented, however, monetary policy has an additional liquidity effect. Changes in the stance of monetary policy affect the distribution of cash balances and consumption expenditures across households. An increase in interest rates induces traders to hold more bonds, to lower their holdings of cash balances, and to reduce their purchases of consumption goods. The traders’ marginal utility of consumption rises, lowering the stochastic discount factor, and increasing expected real returns. The smaller the economic weight of traders in the economy, the larger this liquidity effect of monetary policy on bond real returns. We take the full participation and segmented markets models to the data. Three empirical dimensions are explored: the response of bond returns to nominal interest rate shocks; the autocorrelation of bond returns; and the term structure of volatility. The evidence strongly favours the segmented markets model in each case. The full participation model has incorrect predictions about the impact effect of monetary policy, with real returns rising after an increase in interest rates. Real returns fall in the segmented markets model and closely track the impulse responses in the data thereafter. The segmented markets model also matches the declining positive autocorrelations and increasing volatilities of bond returns as time to maturity increases. The full participation model has negative autocorrelations and can only match the higher volatilities of longer term bond returns by overstating short-term bond volatility. The paper is organized as follows: Section 2 describes the economy and defines the equilibrium; Section 3 explains the numerical solution method; Section 4 presents and comments on the empirical results; Section 5 concludes.
SUMMARRY:
Monetary policy, primarily managed by a central bank, involves adjusting the money supply in an economy through tools like interest rates to influence economic activity, aiming to achieve goals like stable inflation and sustainable growth; by lowering interest rates (expansionary policy), it encourages borrowing and spending, stimulating the economy, while raising interest rates (contractionary policy) can cool down inflation by reducing borrowing and spending.
REFFERENCES:
· Bruce Mizrach, Filippo Occhino (The impact of monetary policy on bond returns: A segmented markets approach)
· Elena Violeta, Drăgoi1 Oana-Mihaela, Ilie (Monetary Policy and its Implications on Economic Growth)
· Farhad Taghizadeh-Hesary, Naoyuki Yoshino, and Sayoko Shimizu (The Impact of Monetary Policy and Tax Policy on Income Inequality)
· Jana Gieck (Unconventional Monetary Policy in an Open Economy)
· KATRIN ASSENMACHER-WESCHE STEFAN GERLACH (Ensuring Financial Stability: Financial Structure and the Impact of Monetary Policy on Asset Prices)
· Octavio Fernandez-Amador, Martin G ´ achter, ¨ Martin Larch, Georg Peter (Monetary policy and its impact on stock market liquidity)
· Owolabi A. Usman, Adegbite Tajudeen Adejare (Impact of Monetary Policy on Industrial Growth)
· Pong pitch Amatyakul Nutnicha Theppornpitak (Fiscal and Monetary Policies in an Agent-Based Model)
· Quelhas, João (Monetary Policy Uncertainty and Its Impact of the real Economy)
· Sensarma, Rudra and Bhattacharyya, Indranil. (Measuring monetary policy and its impact on the emerging economy.)
SUMMARRY:
Monetary policy, primarily managed by a central bank, involves adjusting the money supply in an economy through tools like interest rates to influence economic activity, aiming to achieve goals like stable inflation and sustainable growth; by lowering interest rates (expansionary policy), it encourages borrowing and spending, stimulating the economy, while raising interest rates (contractionary policy) can cool down inflation by reducing borrowing and spending.