Optimal Monetary Policy in the Presence of an Informal Sector and Firm-Level Credit Constraints

Ahmed, Waqas and Khan, Sajawal and Rehman, Muhammad (2013): Optimal Monetary Policy in the Presence of an Informal Sector and Firm-Level Credit Constraints.

Abstract

We analyze, in this paper, the optimality of pro-cyclical monetary policy in the presence of informal sector. Our findings suggest that monetary tightening only in case of severe shock with high leverage ratio and that conventional monetary policy favors both the formal and informal sectors irrespective of the severity of the shocks and hence the whole economy if the size of informal sector is significantly large. Furthermore, fixing exchange rate is better policy option if objective is to defend the employment or domestic consumption from falling when negative shock hits the economy. We can not found any disproportionate impact of policies on informal sector. This may be due to static nature of the model and it might be possible that dynamics of responses of the two sectors to shocks differ significantly.

• Item Type: MPRA Paper
• Language: English
• Keywords: Informal Sector, Credit Constraints, Exchange Rate, Monetary Policy
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; F - International Economics > F0 - General; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O17 - Formal and Informal Sectors ; Shadow Economy ; Institutional Arrangements; O - Economic Development, Innovation, Technological Change, and Growth > O2 - Development Planning and Policy > O23 - Fiscal and Monetary Policy in Development

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