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Monetary policy and the current account; theory and evidence

Listed author(s):
  • Hjortsoe, Ida

    ()

    (Monetary Policy Committee Unit, Bank of England)

  • Weale, Martin

    ()

    (Monetary Policy Committee Unit, Bank of England)

  • Wieladek, Tomasz

    ()

    (Monetary Policy Committee Unit, Bank of England)

Does the current account improve or deteriorate following a monetary policy expansion? We examine this issue theoretically and empirically. We show that a standard open economy DSGE model predicts that the current account response to a monetary policy shock depends on the degree of economic regulation in different markets. In particular, financial (product market) liberalisation makes it more likely that the current account deteriorates (improves) following a monetary expansion. We test these theoretical predictions with a varying coefficient Bayesian panel VAR model, where the coefficients are allowed to vary as a function of the degree of financial, product and labour market regulation on data from 1976 Q1–2006 Q4 for 19 OECD countries. Our empirical results support the theory. We therefore conclude that following a monetary policy expansion, the current account is more likely to go into deficit (surplus) in countries with more liberalised financial (product) markets.

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Paper provided by Monetary Policy Committee Unit, Bank of England in its series Discussion Papers with number 45.

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Length: 71 pages
Date of creation: 04 Mar 2016
Handle: RePEc:mpc:wpaper:0045
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