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The Policy Interest-Rate Pass-Through in Central America

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  • International Monetary Fund
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    Abstract

    Several Central American (CADR) central banks with independent monetary policies have adopted policy interest rates as their main instrument to signal their monetary policy stances, often in the context of adopting or transitioning to inflation targeting regimes. This paper finds that the interest-rate transmission mechanism, or the pass-through of the policy rate to market rates, is generally weaker and slower in CADR than in the LA6, the countries selected as benchmarks. A variety of potential factors behind this finding are examined, including the degrees of financial dollarization, exchange rate flexibility, bank concentration, financial sector development, and fiscal dominance. Through panel data analysis, the study suggests that the transmission mechanism can be strengthened by increasing exchange rate flexibility, and, over time, by adopting measures towards reducing financial dollarization, developing the financial sector, and reducing bank concentration.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 11/240.

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    Length: 21
    Date of creation: 01 Oct 2011
    Date of revision:
    Handle: RePEc:imf:imfwpa:11/240

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    Related research

    Keywords: Financial sector; Latin America; Dollarization; Inflation targeting; exchange rate; monetary policy; central bank; exchange rate flexibility; inflation; monetary fund; monetary policy frameworks; exchange rate anchor; monetary frameworks; monetary transmission; government securities; independent monetary policies; monetary policy independence; exchange rate arrangements; monetary policy framework; monetary policies; open market operations; exchange rate arrangement; transmission of monetary policy; flexible exchange rate; aggregate demand; exchange rates; monetary framework; daily exchange rate; limited exchange rate flexibility; exchange rate volatility; exchange rate band; market for government securities; classification of exchange rate;

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    1. Christopher Crowe & Ellen E. Meade, 2007. "Central Bank Independence and Transparency: Evolution and Effectiveness," Working Papers 2007-20, American University, Department of Economics.
    2. Luis Ignacio Jácome & Francisco F. Vázquez, 2005. "Any Link Between Legal Central Bank Independence and Inflation? Evidence From Latin America and the Caribbean," IMF Working Papers 05/75, International Monetary Fund.
    3. International Monetary Fund, 2007. "Modalities of Moving to Inflation Targeting in Armenia and Georgia," IMF Working Papers 07/133, International Monetary Fund.
    4. Inci Ötker & Charles Freedman, 2010. "Important Elements for Inflation Targeting for Emerging Economies," IMF Working Papers 10/113, International Monetary Fund.
    5. Annamaria Kokenyne & Romain Veyrune & Karl Friedrich Habermeier & Harald Anderson, 2009. "Revised System for the Classification of Exchange Rate Arrangements," IMF Working Papers 09/211, International Monetary Fund.
    6. M Arellano & O Bover, 1990. "Another Look at the Instrumental Variable Estimation of Error-Components Models," CEP Discussion Papers dp0007, Centre for Economic Performance, LSE.
    7. Cukierman, Alex & Webb, Steven B & Neyapti, Bilin, 1992. "Measuring the Independence of Central Banks and Its Effect on Policy Outcomes," World Bank Economic Review, World Bank Group, vol. 6(3), pages 353-98, September.
    8. Luis Jácome & Eric Parrado, 2006. "The Quest for Price Stability in Central America and the Dominican Republic," Working Papers Central Bank of Chile 390, Central Bank of Chile.
    9. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
    10. International Monetary Fund, 2011. "Monetary Transmission in Dollarized and Non-Dollarized Economies," IMF Working Papers 11/87, International Monetary Fund.
    11. Leonardo Leiderman & Rodolfo Maino & Eric Parrado, 2006. "Inflation Targeting in Dollarized Economies," Working Papers Central Bank of Chile 368, Central Bank of Chile.
    12. Philip Turner, 2006. "The banking system in emerging economies: how much progress has been made?," BIS Papers chapters, in: Bank for International Settlements (ed.), The banking system in emerging economies: how much progress has been made?, volume 28, pages 1-9 Bank for International Settlements.
    13. International Monetary Fund, 2010. "Weathering the Global Storm," IMF Working Papers 10/292, International Monetary Fund.
    14. Alessandro Rebucci & Marco A Espinosa-Vega, 2003. "Retail Bank Interest Rate Pass-Through," IMF Working Papers 03/112, International Monetary Fund.
    15. Bernard Laurens & Martin Sommer & Marco Arnone & Jean-François Segalotto, 2007. "Central Bank Autonomy," IMF Working Papers 07/88, International Monetary Fund.
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