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Monetary Policy in Illiquid Markets: Options for a Small Open Economy

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  • Edda Claus
  • Mardi Dungey
  • Renée Fry

    ()

Abstract

Two impediments to effective monetary policy operation include illiquidity in bond markets and the move towards the zero bound of interest rates. Either or both of these scenarios have been evident in many countries in the last decade, raising the suggestion that alternative means of enacting monetary policy may be required. This paper empirically explores policy options implemented through equity and currency markets that will generate similar inflation responses at a short (2 year) and a long (10 year) time frame as those obtained under current arrangements. The results show that current monetary policy arrangements are least costly in terms of the output loss from achieving lower inflation outcomes. However, if this option ceases to be available the next best alternative is to use the equity market option provided a longer run focus is maintained. Focus on short horizons increases the longer term output costs of the policy in all cases.

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Bibliographic Info

Article provided by Springer in its journal Open Economies Review.

Volume (Year): 19 (2008)
Issue (Month): 3 (July)
Pages: 305-336

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Handle: RePEc:kap:openec:v:19:y:2008:i:3:p:305-336

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Web page: http://www.springerlink.com/link.asp?id=100323

Related research

Keywords: Monetary policy alternatives; Illiquid markets; Liquidity trap; Zero bound interest rates; Latent factors; Structural VAR; E52; C51;

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Citations

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Cited by:
  1. Stephen J. Knop & Joaquin L. Vespignani, 2014. "The sectorial impact of commodity price shocks in Australia," CAMA Working Papers 2014-19, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  2. Heather Anderson & Mardi Dungey & Denise Osborn & Farshid Vahid, 2007. "Constructing Historical Euro Area Data," Money Macro and Finance (MMF) Research Group Conference 2006 99, Money Macro and Finance Research Group.
  3. Dungey, Mardi & Osborne, Denise, 2013. "International Transmissions to Australia: The Roles of the US and Euro Area," Working Papers 17208, University of Tasmania, School of Economics and Finance, revised 16 Oct 2013.

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