To What Extent Are the Public and Private Sector Financial Asset Flows Impacted by a Monetary Policy Tightening Shock?

To what extent are the net private and public sector financial asset flows impacted by a tight monetary policy shock? Evidence shows that the net public sector deficit (surplus) should be offset by the net private sector surplus (deficit). In contrast, the private sector experienced an intermittent surplus funds suggesting that it is a net lender. This private sector behaviour is consistent with the procyclicality investment strategy whereas the public sector exhibits a countercyclical investment strategy. Furthermore, a negative shock to GDP and a tight monetary policy shock induce wider public sector deficits. This evidence is contrary to the expectations that public sector financial asset flows do not respond to a monetary policy shock. The negative shocks to GDP and tight monetary policy shocks lead to the widening of the public sector financial asset flow deficits. Net private sector financial asset flows increase for a prolonged period due to a monetary policy tightening shock and a negative shock to GDP. This behaviour is consistent with cash hoarding by the private sector following adverse shocks to the repo rate and GDP. The private sector responses exude net surpluses or a lending status, indicating that elevated cash holdings of the private sector are more pronounced due to negative GDP shocks compared to a tight monetary policy shock. Thus, monetary policy tightening shocks and adverse GDP shocks induce diverging responses (movements in opposite directions) on public and private sector financial asset flows. But GDP plays a more significant role compared to the monetary policy rate dynamics.