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The Effectiveness of Monetary Policy Transmission Under Capital Inflows

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  • Sonali Jain-Chandra
  • D. Filiz Unsal

Abstract

The effectiveness of the monetary policy transmission mechanism in open economies could be impaired if interest rates are driven primarily by global factors, especially during periods of large capital inflows. The main objective of this paper is to assess whether this is true for emerging Asia’s economies. Using a dynamic factor model and a structural vector auto-regression model, we show that long-term interest rates in Asia are indeed predominantly driven by global factors. However, monetary policy transmission mechanism remains effective in the region, as it operates predominantly through short-term interest rates. Nevertheless, the monetary transmission mechanism, though effective, is somewhat weaker in Asia during the periods of surges in capital inflows.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/265.

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Length: 19
Date of creation: 02 Nov 2012
Date of revision:
Handle: RePEc:imf:imfwpa:12/265

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Keywords: Monetary policy; Asia; Emerging markets; Capital inflows; Monetary transmission mechanism; Interest rates; Economic models; long-term interest rates; bond yields; monetary fund; risk aversion; inflation; capital markets; government bond yields; monetary policy transmission mechanism; government bonds; international capital flows; private capital; foreign capital; private capital flows; private capital inflows; aggregate demand; domestic monetary policy; capital inflow episodes; government bond markets; current account deficit; volatile capital; capital accounts;

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  1. Forni M. & Hallin M., 2003. "The Generalized Dynamic Factor Model: One-Sided Estimation and Forecasting," Computing in Economics and Finance 2003, Society for Computational Economics 143, Society for Computational Economics.
  2. Hallin, Marc & Liska, Roman, 2007. "Determining the Number of Factors in the General Dynamic Factor Model," Journal of the American Statistical Association, American Statistical Association, American Statistical Association, vol. 102, pages 603-617, June.
  3. Mahmood Pradhan & Ravi Balakrishnan & Reza Baqir & Geoffrey Heenan & Sylwia Nowak & Ceyda Oner & Sanjaya Panth, 2011. "Policy Responses to Capital Flows in Emerging Markets," IMF Staff Discussion Notes 11/10, International Monetary Fund.
  4. D. Filiz Unsal, 2013. "Capital Flows and Financial Stability: Monetary Policy and Macroprudential Responses," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 9(1), pages 233-285, March.
  5. Forni, Mario & Lippi, Marco, 2001. "The Generalized Dynamic Factor Model: Representation Theory," Econometric Theory, Cambridge University Press, Cambridge University Press, vol. 17(06), pages 1113-1141, December.
  6. Byrne, Joseph P. & Fazio, Giorgio & Fiess, Norbert, 2012. "Interest rate co-movements, global factors and the long end of the term spread," Journal of Banking & Finance, Elsevier, Elsevier, vol. 36(1), pages 183-192.
  7. Kim, Soyoung, 1999. "Do monetary policy shocks matter in the G-7 countries? Using common identifying assumptions about monetary policy across countries," Journal of International Economics, Elsevier, Elsevier, vol. 48(2), pages 387-412, August.
  8. Ronald Lange, 2005. "Determinants of the long-term yield in Canada: an open economy VAR approach," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 37(6), pages 681-693.
  9. Mahmood Pradhan & Shanaka J. Peiris & Mangal Goswami & Dulani Seneviratne & Joshua Felman & Andreas Jobst & Simon Gray, 2011. "Asean Bond Market Development," IMF Working Papers 11/137, International Monetary Fund.
  10. Byrne, Joseph P. & Fazio, Giorgio & Fiess, Norbert, 2010. "Interest Rate Co-movements, Global Factors and the Long End of the Term Spread," SIRE Discussion Papers, Scottish Institute for Research in Economics (SIRE) 2010-24, Scottish Institute for Research in Economics (SIRE).
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