Essays on monetary policy and financial stability

Abstract

Doutoramento em EconomiaBy focusing on the relationship between financial stability and monetary policy for the cases of Chile, Colombia, Japan, Portugal and the UK, this thesis aims to add to the existing literature on the fundamental issue of the relationship between financial stability and monetary policy, a traditional topic that gained importance in the aftermath of the GFC as Central Banks lowered policy rates in an effort to rescue their economies. As the zero-lower bound loomed and the reach of traditional monetary policy narrowed, policy makers realised that alternative frameworks were needed and hence, macroprudential policy measures aimed at targeting the financial system as a whole were introduced. The second chapter looks at the relationship between monetary policy and financial stability, which has gained importance in recent years as Central Bank policy rates neared the zero-lower bound. We use an SVAR model to study the impact of monetary policy shocks on three proxies for financial stability as well as a proxy for economic growth. Monetary policy is represented by policy rates for the EMEs and shadow rates for the AEs in our chapter. Our main results show that monetary policy may be used to correct asset mispricing, to control fluctuations in the real business cycle and also to tame credit cycles in the majority of cases. Our results also show that for the majority of cases, in line with theory, local currencies appreciate following a positive monetary policy shock. Monetary policy intervention may indeed be successful in contributing to or achieving financial stability. However, the results show that monetary policy may not have the ability to maintain or re-establish financial stability in all cases. Alternative policy choices such as macroprudential policy tool frameworks which are aimed at targeting the financial system as a whole may be implemented as a means of fortifying the economy. The third chapter looks at the institutional setting of the countries in question, the independence of the Central Bank, the political environment and the impact of these factors on financial Abstract stability. I substantiate the literature review discussion with a brief empirical analysis of the effect of Central Bank Independence on credit growth using an existing database created by Romelli (2018). The empirical results show that there is a positive relationship between credit growth and the level of Central Bank Independence (CBI) due to the positive and statistically significant coefficient on the interaction term between growth in domestic credit to the private sector and the level of CBI. When considering domestic credit by deposit money banks and other financial institutions, the interaction term is positive and statistically significant for the case of the UK for the third regression equation. A number of robustness checks show that the coefficient is positive and statistically significant for a number of cases when implementing a variety of estimation methods. Fluctuations in credit growth are larger for higher levels of CBI and hence, in periods of financial instability or ultimately financial crises, CBI would be reined back in an effort to re-establish financial stability. Based on the empirical results, and in an effort to slow down surging credit supply and to maintain financial stability, policy makers and governmental authorities should attempt to decrease the level of CBI when the economy shows signs of overheating and credit supply continues to increase. The fourth chapter looks at the interaction between macroprudential policy and financial stability. The unexpected interconnectedness of the global economy and the economic blight that occurred as a result of this, recapitulated the need to implement an alternative policy framework aimed at targeting the financial system as a whole and hence, targeting the maintenance of financial stability. In this chapter, an index of domestic macroprudential policy tools is constructed and the effectiveness of these tools in controlling credit growth, managing GDP growth and stabilising inflation growth is studied using a dynamic panel data model for the period between 2000 and 2017. The empirical analysis includes two panels namely an EU panel of 27 countries and a Latin American panel of 7 countries, the chapter also looks at a case study of Japan, Portugal and the UK. Our main results find that a tighter macroprudential policy tool stance leads to a decrease in both credit growth and GDP growth while, a tighter macroprudential policy tool stance results in higher inflation in the majority of cases. Further, we find that capital openness plays a more important role in the case of Latin America, this may be due to the region’s dependence on foreign capital flows and exchange rate movements. Lastly, we find that, in times of higher perceived market volatility, GDP growth tends to be higher and inflation growth tends to be lower in the EU. In the other cases, higher levels of perceived market volatility result in higher inflation, higher credit growth and lower GDP Abstract growth. This is in line with expectations as an increase in perceived market volatility is met with an increased flow of assets into safer markets such as the EU. This thesis establishes a relationship between financial stability and monetary policy by studying the response of Chile, Colombia, Japan, Portugal and the UK in the aftermath of the GFC as Central Banks lowered policy rates in an effort to rescue their economies. In short, the results of the work conducted in this thesis may be summarised as follows. Our results show that monetary policy contributes to the achievement of financial stability. Still, monetary policy alone is not sufficient and should be reinforced by less traditional policy choices such as macroprudential policy tools. Secondly, we find that the level of CBI should be reined in in times of surging credit supply in an effort to maintain financial stability. Finally, we conclude that macroprudential policy tools play an important role in the achievement of financial stability. These tools should complement traditional monetary policy frameworks and should be adapted for each region.info:eu-repo/semantics/publishedVersio

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