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Financial Intermediation and Monetary Policy in a Small Open Economy

  • Juan David Prada Sarmiento

    ()

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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  1. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
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  5. Andrés González & Lavan Mahadeva & Juan D. Prada & Diego Rodríguez, . "Policy Analysis Tool Applied to Colombian Needs: PATACON Model Description," Borradores de Economia 656, Banco de la Republica de Colombia.
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  9. 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) 740, Bank of Italy, Economic Research and International Relations Area.
  10. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June.
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  12. 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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  14. Oviedo, P. Marcelo, 2005. "World Interest Rate, Business Cycles, and Financial Intermediation in Small Open Economies," Staff General Research Papers Archive 12360, Iowa State University, Department of Economics.
  15. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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