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Financial inclusion and optimal monetary policy

Author

Listed:
  • Aaron Mehrotra
  • James Yetman

Abstract

Limited access to the formal financial sector is a common feature of the economic environment in many emerging market and developing economies. In this paper, we examine how the level of financial inclusion affects welfare-maximising monetary policy. Our theoretical framework is based on Galí, López-Salido and Vallés (2004). In this model, only financially included households are able to borrow and save to smooth consumption in the face of income volatility. We show that optimal monetary policy implies a positive relationship between the share of financially included households and the ratio of output volatility to inflation volatility. We find strong empirical support for the model's predictions using a broad cross-country dataset on financial inclusion. The empirical results are driven primarily by central banks with a high degree of autonomy in their monetary policy decisions, who might be most likely to set monetary policy optimally.

Suggested Citation

  • Aaron Mehrotra & James Yetman, 2014. "Financial inclusion and optimal monetary policy," BIS Working Papers 476, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:476
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    References listed on IDEAS

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Monetary policy and financial inclusion
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2015-06-22 17:43:25

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    Cited by:

    1. repec:taf:oaefxx:v:4:y:2016:i:1:p:1127011 is not listed on IDEAS
    2. Miguel Ampudia & Michael Ehrmann, 2016. "Financial Inclusion—What’s it Worth?," Staff Working Papers 16-30, Bank of Canada.
    3. Aaron Mehrotra & James Yetman, 2015. "Financial inclusion - issues for central banks," BIS Quarterly Review, Bank for International Settlements, March.
    4. Chakrabarti, Anindya S., 2015. "Inflationary effects of monetary policies in newly industrialized economies with cross-sectoral labor and capital immobility," IIMA Working Papers WP2015-08-07, Indian Institute of Management Ahmedabad, Research and Publication Department.
    5. Chakrabarti, Anindya S., 2016. "Inflationary effects of monetary policies in newly industrialized economies with cross-sectoral labor and capital immobility," Journal of Macroeconomics, Elsevier, vol. 50(C), pages 151-167.

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