Targeting financial stress as opposed to the exchange rate

Raputsoane, Leroi (2018): Targeting financial stress as opposed to the exchange rate.

Abstract

This paper analyses the role of monetary policy in targeting financial stress as opposed to the exchange rate in South Africa. This is achieved by augmenting the central bank's monetary policy reaction function with the composite indicator of financial stress and the nominal bilateral exchange rate between the US dollar and the South African rand. The results show that the monetary authorities adopt an accommodative monetary policy stance in the face of financially stressful economic conditions while the opposite is true for the depreciation of the nominal bilateral foreign exchange rate. The results further show a statistically significant reaction of the indicator of financial stress to the changes the monetary policy interest rate while the reaction of the nominal exchange rate is statistically insignificant and negligible. The paper concludes that, although evidence shows that monetary policy in South Africa has reacted to both the indicator of financial stress and the nominal exchange rate, the impact of such a reaction seems to be significant on the indicator financial stress as opposed to the exchange rate.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary policy, Financial stress, Foreign exchange rate
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C11 - Bayesian Analysis: General; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; G - Financial Economics > G0 - General > G01 - Financial Crises

References

Balakrishnan, R., Danninger, S., Elekdag, S., and Tytell, I. (2011). The Transmission of Financial Stress from Advanced to Emerging Economies. Emerging Markets Finance and Trade, 47(2):40–68.

Banbura, M., Giannone, D., and Reichlin, L. (2010). Large Bayesian Vector Autoregressions. Journal of Applied Econometrics, 25(1):71–92.

Bernanke, B. S. (2009). The Crisis and the Policy Response. Rethinking Finance. Russell Sage Foundation and Century Foundation Conference.

Bernanke, B. S. and Boivin, J. (2003). Monetary Policy in a Data Rich Environment. Journal of Monetary Economics, 50:525–546.

Bernanke, B. S. and Gertler, M. (1995). Inside the Black Box: The Credit Channel of Monetary Policy Transmission. Economic Review, 9(4):27–48. Federal Reserve Bank of Kansas City.

Bernanke, B. S. and Gertler, M. (2001). Should Central Banks Respond to Movements in Asset Prices? American Economic Review, 19(2):253–257.

Del Negro, M. and Schorfheide, F. (2011). Bayesian Macroeconometrics. Handbook of Bayesian Econometrics, 1(7):293–387.

Gali, J. and Gambetti, L. (2015). The Effects of Monetary Policy on Stock Market Bubbles: Some Evidence. American Economic Journal, 7(1):233–257.

Giannone, D., Lenza, M., and Primiceri, G. E. (2015). Prior selection for vector autoregressions. Review of Economics and Statistics, 97(2):436–451.

Greenspan, A. (2002). Economic Volatility. Speech. Symposium at Jackson Hole, Wyoming.

Guillermo, A. C. and Reinhart, C. M. (2002). Fear of Floating. Quarterly Journal of Economics, 117(2):379–408.

Hakkio, C. and Keeton, W. (2009). Financial Stress: What is it, How can it be Measured, and Why Does it Matter? Economic Review, 94(2):5–50. Federal Reserve Bank of Kansas City.

Hodrick, R. and Prescott, E. C. (1997). Postwar U.S. Business Cycles: An Empirical Investigation. Journal of Money, Credit and Banking, 29(1):1–16.

Illing, M. and Liu, Y. (2006). Measuring Financial Stress in a Developed Country: An Application to Canada. Journal of Financial Stability, 2(3):243–265.

Kadiyala, K. R. and Karlsson, S. (1997). Numerical Methods for Estimation and Inference in Bayesian VAR models. Journal of Applied Econometrics, 12(2):99–132.

Kafer, B. (2014). The Taylor Rule and Financial Stability: A Literature Review with Application for the Euro zone. Review of Economics, 65(5):159–192.

Kliesen, K., Owyang, M., and Vermann, K. (2012). Disentangling Diverse Measures: A Survey of Financial Stress Indexes. Review of Economics, 94(5):369–398.

Koop, G. and Korobilis, D. (2010). Bayesian Multivariate Time Series Methods for Empirical Macroeconomics. Foundations and Trends in Econometrics, 3(4):267–358.

Koop, G. M. (2013). Forecasting With Medium and Large Bayesian VARs. Journal of Applied Econometrics, 28(2):177–203.

Kremer, M. (2016). Macroeconomic Effects of Financial Stress and the Role of Monetary Policy: A VAR Analysis for the Euro Area. International Economics and Economic Policy, 13(1):105–138.

Litterman, R. (1984). Forecasting and Policy Analysis with Bayesian Vector Autoregression Models. Quarterly Review, Fall. Federal Reserve Bank of Minneapolis.

Mise, E., Kimand, T., and Newbold, P. (2005). On Sub Optimality of the Hodrick Prescott Filter At Time Series Endpoints. Journal of Macroeconomics, 27(1):53–67.

Mishkin, F. S. (2011). Monetary Policy Strategy: Lessons from the Crisis. Working Paper, 16755. National Bureau of Economic Research.

Naraidoo, R. and Paya, I. (2012). Forecasting Monetary Policy Rules in South Africa. International Journal of Forecasting, 28(2):446–455.

Naraidoo, R. and Raputsoane, L. (2010). Zone Targeting Monetary Policy Preferences and Financial Market Conditions. South African Journal of Economics, 78(4):400–417.

Obstfeld, M. and Rogoff, K. (1995). The Mirage of Fixed Exchange Rates. Journal of Economic Perspectives, 9(4):73–96.

OHara, K. (2015). Bayesian Macroeconometrics in R, volume Version 0.5.0. New York University.

Raputsoane, L. (2014). Financial Stress Indicator Variables and Monetary Policy in South Africa. Journal of Economics Bibliography, 3(2):203–214.

Raputsoane, L. (2015). The Lean versus Clean Debate and Monetary Policy in South Africa. Journal of Economics and Political Economy, 2(4):467–480.

Ravn, M. O. and Uhlig, H. (2002). On Adjusting the Hodrick-Prescott Filter for the Frequency of Observations. Review of Economics and Statistics, 84(2):371–376.

Rudebusch, G. D. (1998). Do Measures of Monetary Policy in a VAR Make Sense? International Economic Review, 39(4):907–931.

Sims, C. A. (1980). Macroeconomics and Reality. Journal of Economic Perspectives, 48(1):1–48.

Sims, C. A. (1992). Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy. Journal of Economic Perspectives, 36(5):975–1011.

Sims, C. A. and Uhlig, H. (1991). Understanding Unit Rooters: A Helicopter Tour. Econometrica, 59(6):1591–1599.

Stiglitz, J. E. (2010). Interpreting the Causes of the Great Recession of 2008. In Cecchetti, S. G., Dudley, W., Shirakawa, M., Stiglitz, J. E., and Wellink, N., editors, Financial System and Macroeconomic Resilience: Revisited, volume 53, pages 297–361. MIT Press, Massachusetts.

Stock, J. H. and Watson, M. W. (2001). Vector Autoregressions. Journal of Economic Perspectives, 15(4):101–115. Svensson, L. E. O. (2000). Open Economy Inflation Targeting. Journal of International Economics, 50(1):155–183.

Svensson, L. E. O. (2003). What is Wrong with Taylor Rules? Using Judgment in Monetary Policy Through Targeting Rules. Journal of Economic Literature, 41(2):426–477.

Svensson, L. E. O. (2013). Leaning Against the Leaners. Central Banking, 12:27–36.

Svensson, L. E. O. (2017). Cost Benefit Analysis of Leaning Against the Wind. Journal of Monetary Economics, 90:193–213.

Taylor, J. B. (1993). Discretion versus Policy Rules in Practice. Carnegie-Rochester Conference Series on Public Policy, 39:195–214.

Taylor, J. B. (1999). Robustness and Efficiency of Monetary Policy Rules as Guidelines for Interest Rate Setting. Journal of Monetary Economics, 43(3):655–679.

Taylor, J. B. (2001). The Role of the Exchange Rate in Monetary Policy Rules. American Economic Review, 91(2):263–267.

Trichet, J. C. (2005). Asset Price Bubbles and Monetary Policy. Lecture, June. Monetary Authority of Singapore.

Woodford, M. (1999). Optimal Monetary Policy Inertia. Manchester School, 67(s1):1–35.

Woodford, M. (2012). Inflation Targeting and Financial Stability. Economic Review, 17967. National Bureau of Economic Research.

Yellen, J. (2009). A Minsky Meltdown: Lessons for Central Bankers. Economic Letter, 2009-15. Federal Reserve Bank of San Francisco.