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Optimal Monetary Policy in the Presence of an Informal Sector and Firm-Level Credit Constraints

Author

Listed:
  • Ahmed, Waqas
  • Khan, Sajawal
  • Rehman, Muhammad

Abstract

We analyze, in this paper, the optimality of pro-cyclical monetary policy in the presence of informal sector. Our findings suggest that monetary tightening only in case of severe shock with high leverage ratio and that conventional monetary policy favors both the formal and informal sectors irrespective of the severity of the shocks and hence the whole economy if the size of informal sector is significantly large. Furthermore, fixing exchange rate is better policy option if objective is to defend the employment or domestic consumption from falling when negative shock hits the economy. We can not found any disproportionate impact of policies on informal sector. 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

  • Ahmed, Waqas & Khan, Sajawal & Rehman, Muhammad, 2013. "Optimal Monetary Policy in the Presence of an Informal Sector and Firm-Level Credit Constraints," MPRA Paper 53169, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:53169
    as

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    File URL: https://mpra.ub.uni-muenchen.de/53169/1/MPRA_paper_53169.pdf
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    References listed on IDEAS

    as
    1. Christiano, Lawrence J. & Gust, Christopher & Roldos, Jorge, 2004. "Monetary policy in a financial crisis," Journal of Economic Theory, Elsevier, vol. 119(1), pages 64-103, November.
    2. Muhammad Ali Choudhary & Muhammad Nadim Hanif & Sajawal Khan & Muhammad Rehman, 2012. "Procyclical Monetary Policy and Governance," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 8, pages 33-43.
    3. Sebastian Edwards, 2001. "Exchange Rate Regimes, Capital Flows and Crisis Prevention," NBER Working Papers 8529, National Bureau of Economic Research, Inc.
    4. Merola, Rossana, 2010. "Optimal monetary policy in a small open economy with financial frictions," Discussion Paper Series 1: Economic Studies 2010,01, Deutsche Bundesbank.
    5. Devereux, Michael B & Poon, Doris, 2004. "A Simple Model of Optimal Monetary Policy with Financial Constraints," CEPR Discussion Papers 4370, C.E.P.R. Discussion Papers.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Informal Sector; Credit Constraints; Exchange Rate; Monetary Policy;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • 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

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