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Optimal Monetary Policy in the Presence of Sizable Informal Sector and Firm Level Credit Constraint

Author

Listed:
  • Waqas Ahmed
  • Farooq Pasha
  • Muhammad Rehman

Abstract

Optimality of pro-cyclical monetary policy in the presence of informal sector and firm level constraint is analysed. The findings suggest that in case of export demand shock pro-cyclical monetary policy suits only when shock is severe and domestic firms have high leverage ratio. However, the conventional monetary policy helps cushioning the loss in output when the size of informal sector is significantly large. Furthermore, fixing exchange rate is better policy option if objective is to keep domestic employment or consumption from falling (when negative shock hits the economy). Any disproportionate impact of monetary policy on informal sector is not found. This may be due to static nature of the model and it might be possible that dynamics of responses of the two sectors to shocks differ significantly.

Suggested Citation

  • Waqas Ahmed & Farooq Pasha & Muhammad Rehman, 2016. "Optimal Monetary Policy in the Presence of Sizable Informal Sector and Firm Level Credit Constraint," Working Papers id:10489, eSocialSciences.
    • Handle: RePEc:ess:wpaper:id:10489
    Note: Institutional Papers
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    Cited by:

    1. Khurrum S. Mughal & Friedrich G. Schneider, 2020. "How Informal Sector Affects the Formal Economy in Pakistan? A Lesson for Developing Countries," South Asian Journal of Macroeconomics and Public Finance, , vol. 9(1), pages 7-21, June.
    2. Khurrum S. Mughal & Friedrich G. Schneider & Faheem Aslam & Alishba Tahir, 2021. "Money Multiplier Bias Due to Informal Sector: An Extension of the Existing Money Multiplier," South Asian Journal of Macroeconomics and Public Finance, , vol. 10(2), pages 139-157, December.

    More about this item

    Keywords

    informal sector; firm level; credit constraint; exchange rate and monetary policy; economy; credit constraint; exchange rate depreciation; pro-cyclical; developing;
    All these keywords.

    JEL classification:

    • F0 - International Economics - - General
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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