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Financial Intermediation and Monetary Policy in a Small Open Economy

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  • Juan David Prada Sarmiento

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Abstract

This paper analyses the role of a costly financial system in the transmission of monetary policy. The new-keynesian model for a small open economy is extended with a simple financial system based in Hamann and Oviedo (2006). The presence of the financial intermediation naturally allows the introduction of standard policy instruments: the repo interest rate and the compulsory requirement of reserves. The model is calibrated to match key steady-state ratios of Colombia and is used to evaluate the alternative policy instruments. The financial system plays an important role in the transmission mechanism of the monetary policy, and determines the final effects on aggregated demand and inflation rates of exogenous modifications of the policy instruments. The monetary policy conducted through the repo interest rate has the standard effects predicted by the new-keynesian framework. But changes in the compulsory reserve requirement rate may generate, under different scenarios, totally different reactions on economic activity, and little quantitative effects on inflation rates and aggregate demand. Therefore this last policy instrument appears to be uneffective and unreliable.

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Paper provided by Banco de la Republica de Colombia in its series Borradores de Economia with number 531.

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Handle: RePEc:bdr:borrec:531

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Keywords: Financial intermediation; small open economy; dynamic stochastic general equilibrium model; monetary policy; Colombia. Classification JEL:E32; E44; E52; F41.;

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References

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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Closing Small Open Economy Models," NBER Working Papers 9270, National Bureau of Economic Research, Inc.
  2. Romer, David, 1985. "Financial intermediation, reserve requirements, and inside money: A general equilibrium analysis," Journal of Monetary Economics, Elsevier, Elsevier, vol. 16(2), pages 175-194, September.
  3. Ben S. Bernanke, 1983. "Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression," NBER Working Papers 1054, National Bureau of Economic Research, Inc.
  4. Edwards, Sebastian & Vegh, Carlos A., 1997. "Banks and macroeconomic disturbances under predetermined exchange rates," Journal of Monetary Economics, Elsevier, Elsevier, vol. 40(2), pages 239-278, October.
  5. Brock, Philip L, 1989. "Reserve Requirements and the Inflation Tax," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 21(1), pages 106-21, February.
  6. Oviedo, P. Marcelo, 2005. "World Interest Rate, Business Cycles, and Financial Intermediation in Small Open Economies," Staff General Research Papers, Iowa State University, Department of Economics 12360, Iowa State University, Department of Economics.
  7. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, American Economic Association, vol. 81(4), pages 797-818, September.
  8. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, Elsevier, vol. 46(2), pages 281-313, October.
  9. Andrés González & Lavan Mahadeva & Juan D. Prada & Diego Rodríguez, 2011. "Policy Analysis Tool Applied to Colombian Needs: PATACON Model Description," BORRADORES DE ECONOMIA 008698, BANCO DE LA REPÚBLICA.
  10. Martin Uribe & Vivian Yue, 2004. "Country spreads and emerging countries: who drives whom?," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Jun.
  11. Andrea Gerali & Stefano Neri & Luca Sessa & Federico M. Signoretti, 2010. "Credit and banking in a DSGE model of the euro area," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 740, Bank of Italy, Economic Research and International Relations Area.
  12. Mark Gertler & Simon Gilchrist & Fabio M. Natalucci, 2007. "External Constraints on Monetary Policy and the Financial Accelerator," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 39(2-3), pages 295-330, 03.
  13. Martha R. López & Juan D. Prada & Norberto Rodríguez N., . "Financial Accelerator Mechanism in a Small Open Economy," Borradores de Economia 525, Banco de la Republica de Colombia.
  14. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  15. Andrés Felipe Arias, 2000. "The Colombian Banking Crisis: Macroeconomic Consequences And What To Expect," BORRADORES DE ECONOMIA 003573, BANCO DE LA REPÚBLICA.
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Cited by:
  1. Johana Maritsa Hernández Henao & Last: Hernández Henao, 2013. "Demanda externa, términos de intercambio y el papel de la política monetaria durante la crisis de 2008," Documentos de Investigación - Research Papers, Centro de Estudios Monetarios Latinoamericanos, CEMLA 7, Centro de Estudios Monetarios Latinoamericanos, CEMLA.
  2. Christian Bustamante, 2011. "Política monetaria contracíclica y encaje bancario," BORRADORES DE ECONOMIA 008202, BANCO DE LA REPÚBLICA.
  3. Martha R. López & Juan David Prada, . "Optimal Monetary Policy and Asset Prices: the case of Colombia," Borradores de Economia 583, Banco de la Republica de Colombia.
  4. Luis Eduardo Arango & Nataly Obando & Carlos Esteban Posada, . "Los salarios reales a lo largo del ciclo económico en Colombia," Borradores de Economia 666, Banco de la Republica de Colombia.
  5. Carrera, César, 2012. "Políticas de Encajes y Modelos Económicos," Working Papers, Banco Central de Reserva del Perú 2012-006, Banco Central de Reserva del Perú.

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