Essays in monetary policy

Abstract

This thesis presents a compilation of four essays under the theme of monetary economics. In the first paper, we investigate the endogenous and exogenous drivers of excess liquidity in Papua New Guinea and Fiji using the Generalized Method of Moments specification. These two economies have been hoarding excessively increasing levels of reserves over the past several years and our analyses finds that commercial banks in Papua New Guinea (PNG) are highly risk averse and keep precautionary levels of liquidity over and above the statutorily required minimum. On the other hand, Fijian banks, maintain involuntary levels of excess liquidity.

The presence of excess reserves makes monetary policy weak, and ex ante by implication, impedes the strength of the interest rate channel. The second paper examines monetary transmission in an operational sense in Fiji and PNG using SVAR model. For Fiji, we find that that a shock to policy interest rate (that is, an increase in policy rate decreases the inter-bank rate, while a shock to policy and inter-bank rates decreases the monthly change in excess liquidity. For PNG, a shock to policy interest rate initially decreases the interbank rate but causes a non-dissipating response of the interbank rate after the second month.

The third paper assesses the efficiency of monetary policy in China and India. This paper improves the baseline techniques developed by Li et al. (2010) and Cecchetti et al. (2006) and assesses monetary policy efficiency. Using the stochastic frontier model we estimate the time varying efficiency of achieving the primary and secondary targets of monetary policy with the modified version of the model presented by Li et al., (2010). Results suggest a high level of efficiency in management of output gap compared to inflation gap. Results are mirrored by greater weighting of policymaker preference to output gap. The dynamic accounting analysis following Cecchetti et al., (2006) based on estimates from the Generalised Method of Moments (GMM), assessed on split sample ratios shows an overall decrease in macroeconomic weighted monetary policy efficiency, and overall deterioration in macroeconomic weighted monetary policy efficiency, underpinned by a decrease in macroeconomic performance, variability of supply shock and an increase in monetary policy inefficiency with respect to inflation in India.

The final paper looks at time-varying neutral interest rates for China and India using semi-structural models built on the Taylor Rule (Taylor 1993) – Dynamic and Augmented Taylor Rules – supplemented by similar estimates of neutral interest rates using the common stochastic trends (with and without interest parity conditions) and pure statistical filters to determine the underlying trend as proxy for neutral interest rates. We also apply a two-sided varying coefficient estimator based on GMM, which yields time-varying neutral interest rates as low as just below 2% to just over 6% for China, while time-varying neutral interest rates has fluctuated from 4% to 10% in India. Overall, we find that output gap, inflation gap and inflationary expectation contemporaneously and negatively relate to a tightening real monetary policy stance and vice versa.