It is of significant economic importance to investigate the relationship of the inflation-growth nexus in Sri Lanka, to identify whether there is a linear or non-linear relationship between the two macro variables. This can lead to the discovery of the threshold level of inflation for Sri Lanka. Accordingly, this research explores the inflation-growth relationship in Sri Lanka, using annual data from 1965 to 2014. The results reveal an inflation rate of 9 per cent, which maximises the per capita GDP growth rate in Sri Lanka. However, the results do not confirm any significant structural break in per capita GDP growth rate when the inflation rate exceeds 9 per cent. Therefore, based on the findings, there is no statistically significant evidence to suggest the existence of a non-linear relationship between per capita GDP growth and inflation in Sri Lanka. Some conjectures, such as errors in data and not including savings and investment data can be made regarding the non-existence of a significant inflation threshold. Furthermore, the findings highlight that there is no negative effect of inflation towards the GDP per capita growth at any rate of inflation in Sri Lanka. This is an indication that any adverse effects of contemporaneous inflation are neutralized due to the significant positive effects from the inflation lag of two years. Furthermore, the results are not in favour of the view of maintaining inflation at low levels and thus, this study is important for policymakers in Sri Lanka, when implementing inflation targeting in Sri Lanka in the future.
{"title":"Inflation - Growth Nexus in Sri Lanka: is there a Threshold Level Of Inflation for Sri Lanka?","authors":"B. G. Nilupulee De Silva","doi":"10.4038/SS.V47I2.4704","DOIUrl":"https://doi.org/10.4038/SS.V47I2.4704","url":null,"abstract":"It is of significant economic importance to investigate the relationship of the inflation-growth nexus in Sri Lanka, to identify whether there is a linear or non-linear relationship between the two macro variables. This can lead to the discovery of the threshold level of inflation for Sri Lanka. Accordingly, this research explores the inflation-growth relationship in Sri Lanka, using annual data from 1965 to 2014. The results reveal an inflation rate of 9 per cent, which maximises the per capita GDP growth rate in Sri Lanka. However, the results do not confirm any significant structural break in per capita GDP growth rate when the inflation rate exceeds 9 per cent. Therefore, based on the findings, there is no statistically significant evidence to suggest the existence of a non-linear relationship between per capita GDP growth and inflation in Sri Lanka. Some conjectures, such as errors in data and not including savings and investment data can be made regarding the non-existence of a significant inflation threshold. Furthermore, the findings highlight that there is no negative effect of inflation towards the GDP per capita growth at any rate of inflation in Sri Lanka. This is an indication that any adverse effects of contemporaneous inflation are neutralized due to the significant positive effects from the inflation lag of two years. Furthermore, the results are not in favour of the view of maintaining inflation at low levels and thus, this study is important for policymakers in Sri Lanka, when implementing inflation targeting in Sri Lanka in the future.","PeriodicalId":362386,"journal":{"name":"Staff Studies","volume":"3527 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2017-12-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127515207","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This study examines the economic growth effects of fiscal deficits in the light of policy debates on the Sri Lankan economy during the period 1970 to 2015. More specifically, the study attempts to answer whether the persistent increase in fiscal deficit in Sri Lanka hindered or supported economic growth during the period under review. If it is concluded that economic growth has been negatively affected by fiscal deficits, then the deficits targeting within the Sri Lankan economy becomes extremely important. On the contrary, if fiscal deficits have positively contributed to economic growth, then controlling the size of fiscal deficits becomes expensive in terms of economic development. The empirical evidence in this study confirms that fiscal deficits had an adverse impact on the output growth of the Sri Lankan economy, implying that policy makers needed to control high levels of fiscal deficits to attain the desired levels of growth. The findings further confirm the neoclassical view, which indicates that an increase in fiscal deficits would reduce economic growth, as in the context of the Sri Lankan economy. Moreover, the results reinforce the argument in favour of expeditiously implementing effective strategies for deficit reduction.
{"title":"Growth Effects of Fiscal Deficits in Sri Lanka","authors":"M. Kesavarajah","doi":"10.4038/SS.V47I1.4702","DOIUrl":"https://doi.org/10.4038/SS.V47I1.4702","url":null,"abstract":"This study examines the economic growth effects of fiscal deficits in the light of policy debates on the Sri Lankan economy during the period 1970 to 2015. More specifically, the study attempts to answer whether the persistent increase in fiscal deficit in Sri Lanka hindered or supported economic growth during the period under review. If it is concluded that economic growth has been negatively affected by fiscal deficits, then the deficits targeting within the Sri Lankan economy becomes extremely important. On the contrary, if fiscal deficits have positively contributed to economic growth, then controlling the size of fiscal deficits becomes expensive in terms of economic development. The empirical evidence in this study confirms that fiscal deficits had an adverse impact on the output growth of the Sri Lankan economy, implying that policy makers needed to control high levels of fiscal deficits to attain the desired levels of growth. The findings further confirm the neoclassical view, which indicates that an increase in fiscal deficits would reduce economic growth, as in the context of the Sri Lankan economy. Moreover, the results reinforce the argument in favour of expeditiously implementing effective strategies for deficit reduction.","PeriodicalId":362386,"journal":{"name":"Staff Studies","volume":"94 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2017-06-21","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"116892929","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper examines the dynamic relationship between credit and economic growth in Sri Lanka using aggregated and disaggregated data for the period 2003-2015 in an attempt to decipher the ‘credit-GDP growth puzzle’ experienced recently. The Unrestricted Vector Autoregression (UVAR) approach is followed to account for dynamics and causality tests conducted to determine the direction of the causality between real output and private credit. This is followed by a multiplier analysis to ascertain the direction, timing, magnitude and sensitivity of economic growth to unexpected shocks in private credit. We find evidence supporting the ‘demand-following’ hypothesis, and varying responses of real output to credit shocks at aggregate, sectoral and sub-sectoral levels imply the presence of sectoral heterogeneity to credit impulses. It is therefore imperative that policymakers account for these factors when formulating appropriate (stabilisation) policies to achieve its ultimate objective of price and economic stability.
{"title":"Credit Intensity of Economic Growth – A Sectoral Analysis: Case of Sri Lanka","authors":"W. S. Navin Perera","doi":"10.4038/SS.V47I1.4701","DOIUrl":"https://doi.org/10.4038/SS.V47I1.4701","url":null,"abstract":"This paper examines the dynamic relationship between credit and economic growth in Sri Lanka using aggregated and disaggregated data for the period 2003-2015 in an attempt to decipher the ‘credit-GDP growth puzzle’ experienced recently. The Unrestricted Vector Autoregression (UVAR) approach is followed to account for dynamics and causality tests conducted to determine the direction of the causality between real output and private credit. This is followed by a multiplier analysis to ascertain the direction, timing, magnitude and sensitivity of economic growth to unexpected shocks in private credit. We find evidence supporting the ‘demand-following’ hypothesis, and varying responses of real output to credit shocks at aggregate, sectoral and sub-sectoral levels imply the presence of sectoral heterogeneity to credit impulses. It is therefore imperative that policymakers account for these factors when formulating appropriate (stabilisation) policies to achieve its ultimate objective of price and economic stability.","PeriodicalId":362386,"journal":{"name":"Staff Studies","volume":"42 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2017-06-21","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"120964921","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper characterises fiscal policy rules for Sri Lanka using alternative policy reaction functions for the sample period 2003:Q1 to 2014:Q2. It estimates fiscal policy rules widely used in literature including simple tax difference rules, primary balance rules and Taylor-type fiscal rules. The findings suggest that, first, the fiscal authority responds to changes in output gap and government expenditure moderately. Second, tax smoothing is moderately high and statistically significant. Third, contemporaneous fiscal rules are better than backward-looking rules in characterising the fiscal reaction behaviour in Sri Lanka. Fourth, deficit rules are marginally better than debt rules in matching with Sri Lankan data. Fifth, the fiscal policy in the country is procyclical rather than countercyclical, similar to many other countries. Finally, the contemporaneous Taylor-type fiscal rule that responds to output, government expenditure and deficit while smoothing out tax rate describes the fiscal policy behaviour of Sri Lanka more appropriately than other alternative fiscal rules estimated.
{"title":"Characterising Alternative Fiscal Policy Rules for Sri Lanka","authors":"E. Ehelepola","doi":"10.4038/SS.V45I1-2.4695","DOIUrl":"https://doi.org/10.4038/SS.V45I1-2.4695","url":null,"abstract":"This paper characterises fiscal policy rules for Sri Lanka using alternative policy reaction functions for the sample period 2003:Q1 to 2014:Q2. It estimates fiscal policy rules widely used in literature including simple tax difference rules, primary balance rules and Taylor-type fiscal rules. The findings suggest that, first, the fiscal authority responds to changes in output gap and government expenditure moderately. Second, tax smoothing is moderately high and statistically significant. Third, contemporaneous fiscal rules are better than backward-looking rules in characterising the fiscal reaction behaviour in Sri Lanka. Fourth, deficit rules are marginally better than debt rules in matching with Sri Lankan data. Fifth, the fiscal policy in the country is procyclical rather than countercyclical, similar to many other countries. Finally, the contemporaneous Taylor-type fiscal rule that responds to output, government expenditure and deficit while smoothing out tax rate describes the fiscal policy behaviour of Sri Lanka more appropriately than other alternative fiscal rules estimated.","PeriodicalId":362386,"journal":{"name":"Staff Studies","volume":"45 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2017-02-16","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130815343","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper examines the dynamics of inflation in Sri Lanka using the cointegration approach on quarterly time series data. Considering recent empirical studies in the context of inflation in emerging countries including Sri Lanka, an empirical model has been constructed with seven variables; namely inflation, economic growth, government expenditure, exchange rate, money supply, oil prices and interest rates. The main determinants of inflation in Sri Lanka are the economic growth, exchange rate, government expenditure, money supply, oil prices and interest rates in the long run. According to the estimated impulse response functions, both domestic shocks (money supply, interest rate and economic growth) and external shocks (exchange rate and oil prices) have an effect on inflation in the short run. These findings would be useful for policy makers in their effort in maintaining price stability in Sri Lanka on a sustainable basis.
{"title":"Inflation Dynamics in Sri Lanka: An Empirical Analysis","authors":"Sanduni Kulatunge","doi":"10.4038/SS.V45I1-2.4696","DOIUrl":"https://doi.org/10.4038/SS.V45I1-2.4696","url":null,"abstract":"This paper examines the dynamics of inflation in Sri Lanka using the cointegration approach on quarterly time series data. Considering recent empirical studies in the context of inflation in emerging countries including Sri Lanka, an empirical model has been constructed with seven variables; namely inflation, economic growth, government expenditure, exchange rate, money supply, oil prices and interest rates. The main determinants of inflation in Sri Lanka are the economic growth, exchange rate, government expenditure, money supply, oil prices and interest rates in the long run. According to the estimated impulse response functions, both domestic shocks (money supply, interest rate and economic growth) and external shocks (exchange rate and oil prices) have an effect on inflation in the short run. These findings would be useful for policy makers in their effort in maintaining price stability in Sri Lanka on a sustainable basis.","PeriodicalId":362386,"journal":{"name":"Staff Studies","volume":"45 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2017-02-16","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129835331","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The study examines the transmission of monetary policy impulses to bank retail interest rates in Sri Lanka. Understanding the interest rate pass-through process, from policy rates to bank retail rates are imperative to conduct monetary policy operations successfully. The variables used in this study are central bank policy interest rates that are repo and reverse repo rates, overnight interbank call money market rates, and various types of commercial bank lending and deposit rates. Among other econometric techniques, the Error Correction Mechanism is used in the present study as a main technique to analyse the interest rate pass through mechanism empirically. The data is for the 10-year period from 2003 to 2013. The key conclusion is, in general, that there is no one for one interest rate pass-through to the long-run commercial bank rates from money market rate. Nevertheless, there is a sizable and satisfactory pass-through in the long-run in fixed deposit rates. In contrast, the long-run pass-through is not satisfactory with regard to retail loan interest rates. In the short-run, bank retail rates deviated from the equilibrium due to monetary policy shocks, but were adjusted to their equilibrium levels in the long-run. Also it was found that, on average, short-run adjustment speed of deposit rates is less compared with the lending rates. Further, the short-run adjustment speed is higher for shorter maturities. In general, there is no asymmetry in interest rate pass-through in Sri Lanka.
{"title":"Transmission of Monetary Policy Impulses on Bank Retail Interest Rates: An Empirical Study of Sri Lanka","authors":"Theja Dedu Samarasinghe Pathberiya","doi":"10.4038/SS.V45I1-2.4697","DOIUrl":"https://doi.org/10.4038/SS.V45I1-2.4697","url":null,"abstract":"The study examines the transmission of monetary policy impulses to bank retail interest rates in Sri Lanka. Understanding the interest rate pass-through process, from policy rates to bank retail rates are imperative to conduct monetary policy operations successfully. The variables used in this study are central bank policy interest rates that are repo and reverse repo rates, overnight interbank call money market rates, and various types of commercial bank lending and deposit rates. Among other econometric techniques, the Error Correction Mechanism is used in the present study as a main technique to analyse the interest rate pass through mechanism empirically. The data is for the 10-year period from 2003 to 2013. The key conclusion is, in general, that there is no one for one interest rate pass-through to the long-run commercial bank rates from money market rate. Nevertheless, there is a sizable and satisfactory pass-through in the long-run in fixed deposit rates. In contrast, the long-run pass-through is not satisfactory with regard to retail loan interest rates. In the short-run, bank retail rates deviated from the equilibrium due to monetary policy shocks, but were adjusted to their equilibrium levels in the long-run. Also it was found that, on average, short-run adjustment speed of deposit rates is less compared with the lending rates. Further, the short-run adjustment speed is higher for shorter maturities. In general, there is no asymmetry in interest rate pass-through in Sri Lanka.","PeriodicalId":362386,"journal":{"name":"Staff Studies","volume":"39 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2017-02-16","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127170180","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper examines the dividend policy related literature in order to find evidence by looking at the impact of dividend policy on share price volatility through an analysis of licensed commercial banks listed in Colombo Stock Exchange in Sri Lanka. The panel data least squares method was adopted with the fixed effect model. The impact of dividend yield on share price volatility of licensed commercial banks were found to be insignificant at a 5% significant level with positive correlation, whereas dividend payout had a significant negative correlation as expected with share price volatility, which was substantiated by the empirical evidence from different capital markets as well as dividend related theories. These results suggest that dividend policy has an impact on share price volatility in the Colombo Stock Exchange with regard to banking sector stocks.
{"title":"The Impact of Dividend Policy on Share Price Volatility: Evidence from Banking Stocks in Colombo Stock Exchange","authors":"W. G. R. Harshapriya","doi":"10.4038/SS.V46I1-2.4699","DOIUrl":"https://doi.org/10.4038/SS.V46I1-2.4699","url":null,"abstract":"This paper examines the dividend policy related literature in order to find evidence by looking at the impact of dividend policy on share price volatility through an analysis of licensed commercial banks listed in Colombo Stock Exchange in Sri Lanka. The panel data least squares method was adopted with the fixed effect model. The impact of dividend yield on share price volatility of licensed commercial banks were found to be insignificant at a 5% significant level with positive correlation, whereas dividend payout had a significant negative correlation as expected with share price volatility, which was substantiated by the empirical evidence from different capital markets as well as dividend related theories. These results suggest that dividend policy has an impact on share price volatility in the Colombo Stock Exchange with regard to banking sector stocks.","PeriodicalId":362386,"journal":{"name":"Staff Studies","volume":"41 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-11-28","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129973835","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper examines Real Exchange Rate (RER) misalignment and its impact on export performance of Sri Lanka using quarterly data from 2001 to 2016. The results suggest that the RER in Sri Lanka was misaligned in a wide range during this period, with the range narrowing to less than +/-7 per cent in recent years. Export functions estimated against several variables including RER and its divergence from equilibrium, separately for three main categories of exports -total exports, industrial exports and textile and garments exports -suggest that that RER undervaluation does not have a statistically significant impact on any of these export categories in the long run. However, there is evidence that the RER is a statistically significant determinant of exports in the short run. In the long run, the production capacity has been identified as the major determinant of industrial exports while the trading partner's income plays a significant role in the case of textile and garment exports. This leads to the conclusion that any policy direction pertaining to addressing the long run growth of exports needs to be associated with enhancement of production capacity though short run impulsion could be provided through RER undervaluation.
{"title":"The Impact of Real Exchange Rate and its Misalignment on Export Performance in Sri Lanka","authors":"Sunanda Obeysekera, Hemantha K. J. Ekanayake","doi":"10.4038/SS.V46I1-2.4698","DOIUrl":"https://doi.org/10.4038/SS.V46I1-2.4698","url":null,"abstract":"This paper examines Real Exchange Rate (RER) misalignment and its impact on export performance of Sri Lanka using quarterly data from 2001 to 2016. The results suggest that the RER in Sri Lanka was misaligned in a wide range during this period, with the range narrowing to less than +/-7 per cent in recent years. Export functions estimated against several variables including RER and its divergence from equilibrium, separately for three main categories of exports -total exports, industrial exports and textile and garments exports -suggest that that RER undervaluation does not have a statistically significant impact on any of these export categories in the long run. However, there is evidence that the RER is a statistically significant determinant of exports in the short run. In the long run, the production capacity has been identified as the major determinant of industrial exports while the trading partner's income plays a significant role in the case of textile and garment exports. This leads to the conclusion that any policy direction pertaining to addressing the long run growth of exports needs to be associated with enhancement of production capacity though short run impulsion could be provided through RER undervaluation.","PeriodicalId":362386,"journal":{"name":"Staff Studies","volume":"46 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-11-28","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129672946","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper investigates the causal relationship between financial development and economic growth in Sri Lanka for the period 1965 to 2013 using a trivariate vector autoregressive (VAR) framework that includes investment as an additional variable. This study utilized Per Capita Gross Domestic Product (GDP) and investment (as a measurement of indirect effect) as proxies for economic growth. Money supply, bank deposits and domestic credit to the private sector, each as a percentage of GDP were used as proxies for financial development. Data analysis involved Granger causality tests using the Johansen cointegration test and Vector Error Correction Model (VECM). Results show strong long-run Granger causality of financial development to economic growth in Sri Lanka. Furthermore, results suggest evidence of bi-directional short-run causalities between bank deposits and economic growth, and unidirectional causality from money supply to economic growth. The major implication of research findings is that enhancing financial sector development policies will improve productivity and drive long run economic growth in Sri Lanka.
{"title":"Financial Intermediation Development and Economic Growth Nexus in Sri Lanka","authors":"M. Silva","doi":"10.4038/SS.V46I1-2.4700","DOIUrl":"https://doi.org/10.4038/SS.V46I1-2.4700","url":null,"abstract":"This paper investigates the causal relationship between financial development and economic growth in Sri Lanka for the period 1965 to 2013 using a trivariate vector autoregressive (VAR) framework that includes investment as an additional variable. This study utilized Per Capita Gross Domestic Product (GDP) and investment (as a measurement of indirect effect) as proxies for economic growth. Money supply, bank deposits and domestic credit to the private sector, each as a percentage of GDP were used as proxies for financial development. Data analysis involved Granger causality tests using the Johansen cointegration test and Vector Error Correction Model (VECM). Results show strong long-run Granger causality of financial development to economic growth in Sri Lanka. Furthermore, results suggest evidence of bi-directional short-run causalities between bank deposits and economic growth, and unidirectional causality from money supply to economic growth. The major implication of research findings is that enhancing financial sector development policies will improve productivity and drive long run economic growth in Sri Lanka.","PeriodicalId":362386,"journal":{"name":"Staff Studies","volume":"19 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-11-28","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122429700","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The nominal interest rates were at zero level in the recent past in many countries across the globe. It has been widely debated recently what a central bank should do to stimulate the economy when the nominal interest rate is at the zero lower bound (ZLB). The optimal monetary policy literature suggests that monetary policy inertia, i.e. committing to continue zero interest regime even after the ZLB is not binding, is a way to get the economy out of recession. In this paper, I examine whether this result holds when monetary policy has not only the conventional demand-side effect but also a supply-side effect on the economy. To accomplish this objective, I incorporate the cost channel of monetary policy into an otherwise standard new Keynesian model and evaluate the optimal monetary policy at the ZLB. The study revealed some important insights in the conduct of the optimal monetary policy in a cost channel economy at the ZLB. First, the discretionary policy requires central banks to keep interest rates at the zero lower bound for longer in a cost channel economy compared to no-cost channel economies. This is because, in cost channel economies, the deflation is high and persistent due to a larger negative demand shock than that found in no-cost channel economies. Further, cost channel economies introduce a policy trade-o between inflation and output gap. Under commitment policy, the simulation exercise shows that the central bank is able to terminate the zero interest rate regime earlier in a cost channel economy than otherwise. The reason for that is, in a cost channel economy, the private sector has inflated inflationary expectations when the central bank is planning to conduct a tight monetary policy. This result is in contrast to the results found under discretionary policy. It was also revealed that the cost channel generates substantially high welfare losses, under both discretionary and commitment policies. Accordingly, abstracting the cost channel in these types of models can lead to under estimation of welfare losses.
{"title":"Optimal Monetary Policy at the Zero Lower Bound on Nominal Interest Rates in a Cost Channel Economy","authors":"Lasitha R. C. Pathberiya","doi":"10.4038/ss.v50i1.4720","DOIUrl":"https://doi.org/10.4038/ss.v50i1.4720","url":null,"abstract":"The nominal interest rates were at zero level in the recent past in many countries across the globe. It has been widely debated recently what a central bank should do to stimulate the economy when the nominal interest rate is at the zero lower bound (ZLB). The optimal monetary policy literature suggests that monetary policy inertia, i.e. committing to continue zero interest regime even after the ZLB is not binding, is a way to get the economy out of recession. In this paper, I examine whether this result holds when monetary policy has not only the conventional demand-side effect but also a supply-side effect on the economy. To accomplish this objective, I incorporate the cost channel of monetary policy into an otherwise standard new Keynesian model and evaluate the optimal monetary policy at the ZLB. The study revealed some important insights in the conduct of the optimal monetary policy in a cost channel economy at the ZLB. First, the discretionary policy requires central banks to keep interest rates at the zero lower bound for longer in a cost channel economy compared to no-cost channel economies. This is because, in cost channel economies, the deflation is high and persistent due to a larger negative demand shock than that found in no-cost channel economies. Further, cost channel economies introduce a policy trade-o between inflation and output gap. Under commitment policy, the simulation exercise shows that the central bank is able to terminate the zero interest rate regime earlier in a cost channel economy than otherwise. The reason for that is, in a cost channel economy, the private sector has inflated inflationary expectations when the central bank is planning to conduct a tight monetary policy. This result is in contrast to the results found under discretionary policy. It was also revealed that the cost channel generates substantially high welfare losses, under both discretionary and commitment policies. Accordingly, abstracting the cost channel in these types of models can lead to under estimation of welfare losses.","PeriodicalId":362386,"journal":{"name":"Staff Studies","volume":"11 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2016-09-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114474264","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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