Monetary Policy Transmission Mechanism, Financial Frictions in closed and open economy DSGE models
Date
2017
Authors
Afrin, Sadia
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Abstract
The broad objective of the thesis is to analyze the monetary
policy transmission and relative importance of various shocks in
business cycles after considering the financial sector structure
for both developing and developed countries in three
self-contained chapters (Chapter 2-4). The thesis contributes
both theoretically and empirically to the literature relating to
monetary policy, financial frictions and competition structure,
exchange rate pass through and open economy in general, using
Structural Vector Auto-Regression (SVAR) and Dynamic Stochastic
General Equilibrium (DSGE) models. Since the global financial
crisis, a growing awareness of the roles of financial frictions
has led to renewed interests in transmission mechanisms of
monetary policy and other shocks. Two different financial
frictions are incorporated in the DSGE models of Chapter 3-4
while Chapter 2 does not explicitly model financial friction and
uses SVAR model to analyze the research questions.
The effectiveness of monetary policy and its economy wide
transmission mechanism are relatively unexplored in Bangladesh
where financial sector is still developing. Hence, in Chapter 2,
I investigate the effectiveness of monetary policy and its
transmission mechanism with special emphasis on the lending
channel. A SVAR model for Bangladesh is constructed, taking into
account the exchange rate and monetary policy regimes in the
identification scheme. The estimated model finds support for
empirical regularities and existence of the bank lending channel.
However, exchange rate channel appears less effective, reflecting
a high degree of market intervention by the Bangladesh Bank.
Frictions complicate the role of the financial sector
particularly in the advanced financial markets. Therefore, in
Chapter 3, I analyze the transmission mechanism of investment
specific technology (IST) shock in presence of frictions between
depositors and bankers (a la Gertler and Karadi, 2009) and
implications of considering the capital quality and the net worth
shocks as financial shocks. I use a DSGE framework in Chapter 3
as it allows to design and experiment shocks and frictions
explicitly. The estimated model with a closed economy
representation for the US shows that, financial friction weakens
the impacts of IST shocks in business cycles. Also, the financial
sector is important not only as amplifier of shocks originating
in the real sector, but also as an independent source of shocks
affecting the real economy substantially.
Financial sector in many countries are not as competitive as in
the US. Therefore, the financial friction discussed in Chapter 3
may not be relevant in those countries. Highly concentrated
structure of the financial sector itself creates frictions
affecting bank credits in important ways. Thus, in Chapter 4, I
construct an open economy DSGE model with an oligopolistically
competitive banking sector, considering Australia as an example.
Oligopolistic competition is measured through interest markup
which depends on the number of competing banks. The number of
competitors is determined endogenously. The estimated model for
Australia finds a strong stock market effect in presence of
oligopolistic banks after a monetary policy shock making the
shock less effective and such banks may amplify external shocks.
Also, these banks appear to be more resilient to financial shocks
indicating healthy bank balance sheet positions.
The big picture projected by the dissertation is, the depth and
complexity of the financial sector affect the way intermediaries
contribute to cyclical fluctuations when shocks including
monetary policy hit the economy. For example, IST shock's impacts
on output are weakened by the financial frictions through a bank
balance sheet effect when intermediaries are highly competitive.
However, under oligopolistic bank competition, the IST shock may
not trigger effective enough balance sheet effects due to
strategic behavior among the banks, leaving a large role for the
shock to play. Policy implications of the thesis along with a
discussion on future research directions are summarized in
Chapter 5.
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Monetary policy, Financial frictions, Financial market competition structure, Open economy, SVAR model, DSGE model
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