Essays on the Role of Financial Factors in Monetary Policy PDF Download

Author: Paul Michael Kitney
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Languages : en
Pages : 0

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Book Description
This thesis consists of three essays which explore the role of financial factors in monetary policy from a theoretical and empirical perspective. These essays address the dual policy questions of whether central banks should respond to financial factors and whether there is evidence that they respond to financial factors in setting the policy interest rate. The first essay (Chapter 2) contributes to the debate whether central banks should respond to asset prices and other financial factors in setting monetary policy, by evaluating determinacy and expectational stability of equilibria under various monetary policy rules. Financial frictions are introduced by extending the determinacy and adaptive learning methodology embodied in Bullard and Mitra (2002) and Bullard and Mitra (2002), via a Financial Accelerator [Bernanke, Gertler and Gilchrist (1999)]. A key result is that monetary policy rules responding to lagged asset prices and credit volume have less desirable determinacy and learnability characteristics than responding to current asset prices and credit spreads. The results in both Bullard and Mitra (2002) and Bullard and Mitra (2007) are robust to this modelling framework. The second essay (Chapter 3) has two objectives. The first is to discover whether there is evidence that central banks are influenced by stock prices in setting the monetary policy interest rate. The second is to examine implications of including a central bank in a long-run SVAR, modelled by placing short-run restrictions on interest rates. An SVAR model of the Australian economy, based on long-run identification in Fry, Hocking and Martin (2008) is estimated with a focus on short-run dynamics. Short-run restrictions are imposed to identify central bank behaviour. Other modifications include financial frictions and alternate nominal variable assumptions. The key finding is that there is evidence the central bank responded to portfolio shocks but this is more conclusive when macro-financial linkages or financial frictions are present. An analytical finding is that if a short-run zero restriction on nominal shocks in the policy interest rate equation is imposed then nominal shocks have no effect on long-run prices or any other long run parameters in the model. Variance decomposition analysis shows that this restriction lowers the long-run attribution of interest rates to stock price variability, among other findings. The third essay (Chapter 4) estimates a version of a New Keynesian DSGE model with financial frictions for the United States using Bayesian techniques. Various Henderson-McKibbin-Taylor style monetary policy rules are examined, which react to credit market factors. The research question is whether the central bank responds to credit market factors in setting the policy interest rate, which is investigated using posterior odds tests. There is also an inquiry as to whether there is evidence of macroeconomic stabilization, conducted using impulse response analysis and an examination of parameter posterior distributions. The core result is that over the time period tested, US Fed responded to credit spreads in setting the policy rate. The empirical results also confirm that credit spreads offer stabilization benefits and these results are robust to variations in the policy rule.