The Effectiveness of Monetary Policy in Small Open Economies: An Empirical Investigation

September 16, 2016

Preview Citation

Format: Chicago

Keyra Primus. The Effectiveness of Monetary Policy in Small Open Economies: An Empirical Investigation, (USA: International Monetary Fund, 2016) accessed December 22, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper examines the relative effectiveness of the use of indirect and direct monetary policy instruments in Barbados, Jamaica and Trinidad and Tobago, by estimating a restricted Vector Autoregressive model with Exogenous Variables (VARX). The study assumes that the central bank conducts monetary policy using a Taylor-type rule and it evaluates the effects of a reserve requirement policy. The results show that although a positive shock to the policy interest rate has a direct effect on commercial banks' interest rates, there is a weak transmission to the real variables. Furthermore, an increase in the required reserve ratio is successful in reducing private sector credit and excess reserves, while at the same time alleviating pressures on the exchange rate. The findings therefore indicate that central banks in small open economies should consider using reserve requirements as a complement to interest rate policy, to achieve their macroeconomic objectives.

Subject: Banking, Central bank policy rate, Financial services, Inflation, Monetary policy, Prices, Prime rates, Reserve requirements, Short term interest rates

Keywords: Bank liquidity, Caribbean, Central bank, Central bank policy rate, Changes in Barbados, Contractionary monetary policy, Contractionary monetary policy shock, Effect monetary policy, Exchange rate, Inflation, Interest rate change, Interest rate changes in Barbados, Interest rate channel, Macroeconometric Model, Monetary policy shock, Monetary policy tool, Policy interest rate, Policy interest rate in the baseline experiment, Prime rates, Required reserve ratio, Reserve ratio, Reserve Requirements, Short term interest rates, Small Open Economies, WP

Publication Details

Pages:

39
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2016/189
Stock No:

WPIEA2016189
ISBN:

9781475536874
ISSN:

1018-5941

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