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Threshold effects of financial stress on monetary policy rules: A panel data analysis

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  • Floro, Danvee
  • van Roye, Björn

Abstract

This study tests for the state-dependent response of monetary policy to increases in overall financial stress and financial sector-specific stress across a panel of advanced and emerging economy countries. We use a factor-augmented dynamic panel threshold regression model with (estimated) common error components to deal with cross-sectional dependence. We find strong evidence of advanced economy countries' aggressive monetary policy loosening in response to stock market and banking stress but only in times of high financial market volatility. By comparison, evidence of threshold effects of financial stress is generally weak for emerging market countries’ interest rate decisions.

Suggested Citation

  • Floro, Danvee & van Roye, Björn, 2017. "Threshold effects of financial stress on monetary policy rules: A panel data analysis," International Review of Economics & Finance, Elsevier, vol. 51(C), pages 599-620.
  • Handle: RePEc:eee:reveco:v:51:y:2017:i:c:p:599-620
    DOI: 10.1016/j.iref.2017.07.023
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    Keywords

    Financial stress; Monetary policy; Factor-augmented dynamic panel threshold regression; Cross-sectional dependence;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • C24 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Truncated and Censored Models; Switching Regression Models; Threshold Regression Models

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