Essays on the monetary transmission mechanism
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Beschreibung
Monetary neutrality in the long run appears to be one of the least controversial issues in macroeconomics. Turning to the short run however, money matters and monetary policy will affect the real economy through different channels. The monetary transmission mechanism describes the manner in which monetary policy changes and policy shocks, either in the nominal money stock or the short term interest rate, affect real variables (Mishkin, 1995, and Ireland, 2005).
The special focus in this work lies on the liquidity effect. This term refers to a persistent decline in the nominal interest rate following a monetary expansion. This effect has been confirmed by a large amount of empirical literature and is now seen as common wisdom in monetary macroeconomics.
Several approaches have been considered to model the liquidity effect and to learn more about the exact driving forces behind this effect. Popular approaches are limited participation models on the one hand and sticky price models on the other.
Even though a considerable amount of economic research has been devoted to the subject of the liquidity effect, many open questions remain in this area. The aim of this thesis is to fill part of this gap in the literature and link the role of three key macroeconomic parameters to the size of the liquidity effect. These are the degree of international capital mobility, the degree of openness in international trade, and the chosen exchange rate regime of a particular economy.
Therefore, the second chapter presents an empirical investigation of the liquidity effect. The analysis investigates the cross-country variation of this effect in a sample of 27 countries. The response of the short term nominal interest rate to an expansionary monetary shock is estimated with the use of a vector autoregression model (VAR). This approach allows imposing only minimal identification assumptions, not biased towards any prior structural beliefs about the monetary transmission mechanism. In the second stage of the analysis, a regression analysis examines the role of the degree of international capital mobility, the degree of openness in international trade, and the degree of exchange rate flexibility by employing an empirical measure of each. Indeed, it can be shown that there is a relationship. A robustness analysis, distinguishing sample periods, groups of countries and the monetary aggregate employed, highlights the steadiness of the results.
Next, we compare the results obtained from the data to the predictions of the classic open economy IS-LM model, better known as the Mundell-Fleming model (Mundell, 1962, and Fleming, 1962). Besides well known shortcomings in the shape of a lack of a solid micro foundation and missing market clearing, this model provides only limited insight into the relation between the size of the liquidity effect and the three parameters of interest, so a more advanced model should be used.
Therefore, the third chapter develops a dynamic stochastic general equilibrium model of a small economy. The model is set up in a new Keynesian fashion, including nominal and real rigidities. Importantly, the latter rigidity in the form of investment adjustment costs (Christiano, Eichenbaum and Evans, 2005) is the only feature able to generate a liquidity effect in the new Keynesian model (Dellas and Collard, 2006). The model is calibrated to a generic economy rather than to a particular one in order to permit a general comparison. Indeed, it can be shown that the size of the liquidity effect depends on the degree of international capital mobility, the degree of openness in international trade, as well as the exchange rate regime in place. A comparison of the model's predictions with the empirical results from chapter 2 follows. Remarkably, in the second half of the sample period, empirical support for the new Keynesian model increases markedly, suggesting a change in monetary policy across the considered countries.
To give this issue more attention, the fourth chapter pursues an empirical analysis of the stability of the monetary transmission mechanism with a special focus on Switzerland and Germany. Especially the decline in inflation and output volatilities in both countries calls for a deeper investigation. A comprehensive stability analysis based on vector autoregeressive models detects instability in both countries, robust to the use of alternative tests. There are two candidate sources for this instability: a change in the propagation mechanism of monetary shocks or a change in the volatility of these shocks. Many studies examine this question for the US economy (e.g. Boivin and Giannoni, 2002, and Stock and Watson, 2002), where a similar decline in the volatilities of inflation and output was observed. This literature refers to the change in the propagation mechanism as the "better monetary policy" hypothesis and the change in the volatility of shocks itself as the "good luck" hypothesis. Using the found break dates, a counterfactual experiment helps to examine the sources of the instability of the monetary transmission mechanism in Switzerland and Germany. As a result of this counterfactual experiment, we find that the decline in volatilities of inflation and output in both countries is attributable to both hypotheses, the "better policy" hypothesis and the "good luck" hypothesis.
Autor*in
Jerry J Suk
Themen in »Essays on the monetary transmission mechanism«
DSGE Model New Keynesian Model VAR capital mobility exchange rate regime liquidity effect trade openness