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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.

Suggested Citation

  • Juan David Prada Sarmiento, 2008. "Financial Intermediation and Monetary Policy in a Small Open Economy," Borradores de Economia 531, Banco de la Republica de Colombia.
  • Handle: RePEc:bdr:borrec:531
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Christian Glocker & Pascal Towbin, 2012. "Reserve Requirements for Price and Financial Stability: When Are They Effective?," International Journal of Central Banking, International Journal of Central Banking, vol. 8(1), pages 65-114, March.
    2. Carrera, César, 2012. "Políticas de Encajes y Modelos Económicos," Working Papers 2012-006, Banco Central de Reserva del Perú.
    3. Agénor, Pierre-Richard & Alper, Koray & Pereira da Silva, Luiz A., 2014. "Sudden floods, macroprudential regulation and stability in an open economy," Journal of International Money and Finance, Elsevier, vol. 48(PA), pages 68-100.
    4. Martha R. López & Juan David Prada, 2010. "Optimal Monetary Policy And Asset Prices: The Case Of Colombia," ENSAYOS SOBRE POLÍTICA ECONÓMICA, BANCO DE LA REPÚBLICA - ESPE, vol. 28(61), pages 167-197, August.
    5. Luis Eduardo Arango & Nataly Obando & Carlos Esteban Posada, 2011. "Los salarios reales a lo largo del ciclo económico en Colombia," Borradores de Economia 666, Banco de la Republica de Colombia.
    6. Pierre-Richard Agénor & K. Alper & L. Pereira da Silva, 2015. "External Shocks, Financial Volatility and Reserve Requirements in an Open Economy," Working Papers Series 396, Central Bank of Brazil, Research Department.
    7. Christian Bustamante, 2011. "Política monetaria contracíclica y encaje bancario," BORRADORES DE ECONOMIA 008202, BANCO DE LA REPÚBLICA.
    8. Johana Maritsa 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 7, Centro de Estudios Monetarios Latinoamericanos, CEMLA.

    More about this item

    Keywords

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

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • 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
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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