Monetary Policy, Financial Markets And Macroeconomic Stability

Syed Kashif, Saeed (2013) Monetary Policy, Financial Markets And Macroeconomic Stability. Doctoral thesis, Comsats Institute Of Information Technology, Islamabad.

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Abstract

After more than four decades of research in monetary economics, it was argued that an overall consensus had been achieved on how monetary policy should be conducted.The global financial crisis of 2008 has, not only shaken the so-called consensus on monetary policy but also made economists and policy makers realize that instability in financial markets has the potential to endanger the entire economic system.The concern towards financial stability raised the question, whether the monetary authorities should explicitly consider financial market dynamics in devising a monetary policy stance.This dissertation aims at investigating the impact of monetary policy stance on macroeconomic stability and financial market stability in Pakistan, during the years 1991 to 2010. The impact of monetary policy stance on macroeconomic stability has been investigated by estimating a monetary policy reaction function and then simulating a New Keynesian macro-economic model. In addition, to investigate that how monetary policy stance impacts financial markets stability, structural VAR model in levels has been estimated.This study concludes that in Pre 1999 era, monetary policy stance was more counter-inflationary whereas in post 1999 era, the monetary policy stance was relatively accommodative.The simulation results suggest that accommodative monetary policy lead to higher and more unpredictable inflation. The conclusion is drawn that the latter policy regime caused inflationary expectations to build up starting from the year 2005, and the inflation eventually spiraled sharply out of control to almost 20% in year 2008, before being brought down by aggressive monetary tightening by State Bank of Pakistan.In addition, this study concludes that the monetary policy significantly influenced financial market stability in Pakistan. However, the structural VAR analysis suggests that the monetary authorities in Pakistan do not consider the financial (market) stability while setting the interest rates.Both methodologies in this study (i.e. simulation of New Keynesian macro model and estimation of Structural VAR) provide consistent findings with respect to macro-economic and financial stability.Accommodative monetary policy, and failure to avoid persistent inflation, can lead to macroeconomic instability as well as instability in financial markets.More importantly, the results indicate that moving aggressively to contain inflation and avoiding persistent inflation can also help achieve stability of financial markets. The results of the analysis do not provide support for explicitly including financial market indicators in monetary policy reaction function.Therefore, it is concluded that targeting inflation that prevents inflationary expectation from getting entrenched appears to be a reasonably sound policy that could achieve the twin objectives of macroeconomic and financial market stability.

Item Type: Thesis (Doctoral)
Uncontrolled Keywords: Stability, Monetary, Macroeconomic, Policy, Markets, Financial
Subjects: H Social Sciences > HD Industries. Land use. Labor > HD28 Management. Industrial Management
Depositing User: Muhammad Khan Khan
Date Deposited: 07 Oct 2016 06:02
Last Modified: 07 Oct 2016 06:02
URI: http://eprints.hec.gov.pk/id/eprint/2314

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