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The Effectiveness of Monetary Policy Transmission Under Capital Inflows; Evidence from Asia

  • Sonali Jain-Chandra
  • D. Filiz Unsal

The effectiveness of the monetary policy transmission mechanism in open economies could be impaired if interest rates are driven primarily by global factors, especially during periods of large capital inflows. The main objective of this paper is to assess whether this is true for emerging Asia’s economies. Using a dynamic factor model and a structural vector auto-regression model, we show that long-term interest rates in Asia are indeed predominantly driven by global factors. However, monetary policy transmission mechanism remains effective in the region, as it operates predominantly through short-term interest rates. Nevertheless, the monetary transmission mechanism, though effective, is somewhat weaker in Asia during the periods of surges in capital inflows.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/265.

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Length: 19
Date of creation: 02 Nov 2012
Date of revision:
Handle: RePEc:imf:imfwpa:12/265
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  1. D. Filiz Unsal, 2011. "Capital Flows and Financial Stability; Monetary Policy and Macroprudential Responses," IMF Working Papers 11/189, International Monetary Fund.
  2. Mario Forni & Marc Hallin & Marco Lippi & Lucrezia Reichlin, 2005. "The generalised dynamic factor model: one sided estimation and forecasting," ULB Institutional Repository 2013/10129, ULB -- Universite Libre de Bruxelles.
  3. Kim, Soyoung, 1999. "Do monetary policy shocks matter in the G-7 countries? Using common identifying assumptions about monetary policy across countries," Journal of International Economics, Elsevier, vol. 48(2), pages 387-412, August.
  4. Ronald Lange, 2005. "Determinants of the long-term yield in Canada: an open economy VAR approach," Applied Economics, Taylor & Francis Journals, vol. 37(6), pages 681-693.
  5. Mahmood Pradhan & Shanaka J. Peiris & Mangal Goswami & Dulani Seneviratne & Joshua Felman & Andreas Jobst & Simon Gray, 2011. "Asean Bond Market Development; Where Does it Stand? Where is it Going?," IMF Working Papers 11/137, International Monetary Fund.
  6. Mahmood Pradhan & Ravi Balakrishnan & Reza Baqir & Geoffrey Heenan & Sylwia Nowak & Ceyda Oner & Sanjaya Panth, 2011. "Policy Responses to Capital Flows in Emerging Markets," IMF Staff Discussion Notes 11/10, International Monetary Fund.
  7. Joseph P. Byrne & Giorgio Fazio & Norbert Fiess, 2010. "Interest Rate Co-movements, Global Factors and the Long End of the Term Spread," Working Papers 2010_10, Business School - Economics, University of Glasgow.
  8. Hallin, Marc & Liska, Roman, 2007. "Determining the Number of Factors in the General Dynamic Factor Model," Journal of the American Statistical Association, American Statistical Association, vol. 102, pages 603-617, June.
  9. Forni, Mario & Lippi, Marco, 2001. "The Generalized Dynamic Factor Model: Representation Theory," Econometric Theory, Cambridge University Press, vol. 17(06), pages 1113-1141, December.
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