ACADEMY OF ECONOMIC STUDIESDOCTORAL SCHOOL OF FINANCE AND BANKING

DISSERTATION PAPER

SOME ASPECTS REGARDING MONETARY POLICY TRANSMISSION MECHANISM IN CENTRAL AND EASTERN

EUROPEAN COUNTRIES

MSc Student: Andrei Birman

Supervisor: Professor Moisă Altăr

BUCHAREST -2004

Content

1. Introduction

2. Monetary policy transmission mechanism; theory and evidence

3. Identification and estimation

4. Discussion of the results

5. Concluding remarks

References

Monetary policy transmission mechanism

• Traditional interest rate channel; Blinder, 1997:”interest sensitivity of business investment spending is subject to doubt……may have more to do with homebuilding and consumer durables”

• Other assets price channel: exchange rates: affect relative prices between domestic and foreign goods affect domestic/foreign demand for domestic goodsaggregate demand channel

equities • Credit view: (Bernanke, Gertler) emphasize a combination of asymmetric

information problems in credit markets and portfolio balance effects based on imperfect asset substitutability

bank lending channel

balance sheet channel – “finnacial accelerator”: the impact on investment of small interest changes is magnified by balance sheet effects;

• Modern view (Cecchetti): assigns a special role to the financial structure and legal system.

IDENTIFICATION and ESTIMATION

Vector Autoregressions –VARsCholesky decomposition

Model 1 [P Y E R M2] Model 2 [P Y E R M1]• Czech Republic 1998:01-2004:01 (1997 - currency turbulence and price liberalization)

• Hungary 1998:01-2004:02 (still some monetary policy independence; availability of data)

• Poland 1997:06 – 2004:01 (exchange rate band +/- 10% )

• Romania 1997:06 – 2004:01 ( 1997 price liberalization)

Variables used:

4.8

4.9

5.0

5.1

5.2

5.3

5.4

1999 2000 2001 2002 2003

industrial production, sa

5.1

5.2

5.3

5.4

5.5

5.6

1999 2000 2001 2002 2003

CPI, sa

8.4

8.5

8.6

8.7

8.8

8.9

9.0

9.1

1999 2000 2001 2002 2003

M2, sa

7.5

7.6

7.7

7.8

7.9

8.0

8.1

8.2

8.3

1999 2000 2001 2002 2003

M1, sa

4.10

4.15

4.20

4.25

4.30

1999 2000 2001 2002 2003

NEER

4

6

8

10

12

14

16

1999 2000 2001 2002 2003

treasury rate

HUNGARY

4.84

4.88

4.92

4.96

5.00

5.04

1998 1999 2000 2001 2002 2003

cpi, sa

4.60

4.64

4.68

4.72

4.76

4.80

4.84

4.88

4.92

4.96

1998 1999 2000 2001 2002 2003

industrial production, sa

4.50

4.55

4.60

4.65

4.70

4.75

4.80

4.85

1998 1999 2000 2001 2002 2003

NEER

5.9

6.0

6.1

6.2

6.3

6.4

6.5

6.6

6.7

1998 1999 2000 2001 2002 2003

M1, sa

7.0

7.1

7.2

7.3

7.4

7.5

1998 1999 2000 2001 2002 2003

M2, sa

0

4

8

12

16

20

1998 1999 2000 2001 2002 2003

money market rate

CZECH REPUBLIC

4.9

5.0

5.1

5.2

5.3

1997 1999 2000 2001 2002 2003

cpi, sa

4.7

4.8

4.9

5.0

5.1

5.2

1997 1999 2000 2001 2002 2003

industrial production, sa

4.20

4.25

4.30

4.35

4.40

4.45

4.50

4.55

1997 1999 2000 2001 2002 2003

NEER, sa

11.0

11.2

11.4

11.6

11.8

12.0

12.2

1997 1999 2000 2001 2002 2003

M1, sa

11.9

12.0

12.1

12.2

12.3

12.4

12.5

12.6

12.7

12.8

1997 1999 2000 2001 2002 2003

M2, sa

4

8

12

16

20

24

28

1997 1999 2000 2001 2002 2003

Money market rate

POLAND

10.4

10.8

11.2

11.6

12.0

12.4

1997 1999 2000 2001 2002 2003

cpi , sa

4.25

4.30

4.35

4.40

4.45

4.50

4.55

4.60

4.65

1997 1999 2000 2001 2002 2003

industrial production, sa

.05

.10

.15

.20

.25

.30

.35

.40

.45

1997 1999 2000 2001 2002 2003

NEER

20

30

40

50

60

70

80

90

100

1997 1999 2000 2001 2002 2003

lending rate

0

20

40

60

80

100

120

140

1997 1999 2000 2001 2002 2003

interbank rate

16.0

16.5

17.0

17.5

18.0

18.5

1997 1999 2000 2001 2002 2003

M1, sa

17.5

18.0

18.5

19.0

19.5

20.0

1997 1999 2000 2001 2002 2003

M2, sa

ROMANIA

Poland – unit root tests

Polonia - Model 1 [P Y E R M2] – 2 lags

Equation for prices

Equation for industrial production

Equation for nominal effective exchange rate

Equation for interest rate

Equation for M2

Identification of Interest rate shocks(full line – impulse response function; dotted lines – 2 Std.error bands)

-.004

-.002

.000

.002

.004

2 4 6 8 10 12 14 16 18 20 22 24

of P to R

-.010

-.005

.000

.005

.010

.015

.020

.025

2 4 6 8 10 12 14 16 18 20 22 24

of Y to R

-.010

-.005

.000

.005

.010

.015

.020

2 4 6 8 10 12 14 16 18 20 22 24

of E to R

-.004

-.002

.000

.002

.004

.006

.008

.010

2 4 6 8 10 12 14 16 18 20 22 24

of M1 to R

Response to Cholesky One S.D. Innovations ± 2 S.E.

Cze

ch R

.

-.006

-.004

-.002

.000

.002

.004

2 4 6 8 10 12 14 16 18 20 22 24

of P to R

-.02

-.01

.00

.01

.02

.03

.04

2 4 6 8 10 12 14 16 18 20 22 24

of Y to R

-.012

-.008

-.004

.000

.004

.008

.012

.016

.020

2 4 6 8 10 12 14 16 18 20 22 24

of E to R

-.008

-.004

.000

.004

.008

.012

.016

2 4 6 8 10 12 14 16 18 20 22 24

of M1to R

Response to Cholesky One S.D. Innovations ± 2 S.E.

HU

NG

AR

Y

-.006

-.004

-.002

.000

.002

.004

.006

.008

2 4 6 8 10 12 14 16 18 20 22 24

of P to R

-.02

-.01

.00

.01

.02

.03

2 4 6 8 10 12 14 16 18 20 22 24

of Y to R

-.02

-.01

.00

.01

.02

.03

2 4 6 8 10 12 14 16 18 20 22 24

of E to R

-.03

-.02

-.01

.00

.01

.02

.03

2 4 6 8 10 12 14 16 18 20 22 24

of M1 to R

PO

LA

ND

-.020

-.015

-.010

-.005

.000

.005

.010

2 4 6 8 10 12 14 16 18 20 22 24

of P to R

-.02

-.01

.00

.01

.02

.03

.04

2 4 6 8 10 12 14 16 18 20 22 24

of Y to R

-.004

-.002

.000

.002

.004

.006

.008

2 4 6 8 10 12 14 16 18 20 22 24

of E to R

-.02

-.01

.00

.01

.02

.03

2 4 6 8 10 12 14 16 18 20 22 24

of M1 to R

RO

MA

NIA

Identification of Money shocks(full line – impulse response function; dotted lines – 2 Std.error bands)

 Responses to money shock (first row M2, second row M1)

-.006

-.004

-.002

.000

.002

.004

2 4 6 8 10 12 14 16 18 20 22 24

of P to M2

-.010

-.005

.000

.005

.010

.015

.020

.025

2 4 6 8 10 12 14 16 18 20 22 24

of Y to M2

-.010

-.005

.000

.005

.010

.015

.020

2 4 6 8 10 12 14 16 18 20 22 24

of E to M2

-.6

-.4

-.2

.0

.2

.4

2 4 6 8 10 12 14 16 18 20 22 24

of R to M2

-.004

-.002

.000

.002

.004

2 4 6 8 10 12 14 16 18 20 22 24

of P to M1

-.010

-.005

.000

.005

.010

.015

.020

.025

2 4 6 8 10 12 14 16 18 20 22 24

of Y to M1

-.010

-.005

.000

.005

.010

.015

.020

2 4 6 8 10 12 14 16 18 20 22 24

of E to M1

-.5

-.4

-.3

-.2

-.1

.0

.1

.2

.3

.4

2 4 6 8 10 12 14 16 18 20 22 24

of R to M1

CZEC

H R

.

-.004

-.002

.000

.002

.004

2 4 6 8 10 12 14 16 18 20 22 24

of P to M2

-.02

-.01

.00

.01

.02

.03

.04

2 4 6 8 10 12 14 16 18 20 22 24

ofY to M2

-.010

-.005

.000

.005

.010

.015

.020

2 4 6 8 10 12 14 16 18 20 22 24

of E to M2

-0.4

0.0

0.4

0.8

2 4 6 8 10 12 14 16 18 20 22 24

of R to M2

-.006

-.004

-.002

.000

.002

.004

2 4 6 8 10 12 14 16 18 20 22 24

of P to M1

-.02

-.01

.00

.01

.02

.03

.04

2 4 6 8 10 12 14 16 18 20 22 24

of Y to M1

-.012

-.008

-.004

.000

.004

.008

.012

.016

.020

2 4 6 8 10 12 14 16 18 20 22 24

of E to M1

-0.4

0.0

0.4

0.8

2 4 6 8 10 12 14 16 18 20 22 24

of R to M1

HU

NG

AR

Y

-.006

-.004

-.002

.000

.002

.004

.006

2 4 6 8 10 12 14 16 18 20 22 24

of P to M2

-.02

-.01

.00

.01

.02

.03

2 4 6 8 10 12 14 16 18 20 22 24

of Y to M2

-.02

-.01

.00

.01

.02

.03

2 4 6 8 10 12 14 16 18 20 22 24

of E to M2

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2 4 6 8 10 12 14 16 18 20 22 24

of R to M2

-.006

-.004

-.002

.000

.002

.004

.006

.008

2 4 6 8 10 12 14 16 18 20 22 24

of P to M1

-.02

-.01

.00

.01

.02

.03

2 4 6 8 10 12 14 16 18 20 22 24

of Y to M1

-.02

-.01

.00

.01

.02

.03

2 4 6 8 10 12 14 16 18 20 22 24

of E to M1

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2 4 6 8 10 12 14 16 18 20 22 24

of R to M1

PO

LA

ND

-.020

-.015

-.010

-.005

.000

.005

.010

.015

2 4 6 8 10 12 14 16 18 20 22 24

of P to M2

-.02

-.01

.00

.01

.02

.03

.04

2 4 6 8 10 12 14 16 18 20 22 24

of Y to M2

-.006

-.004

-.002

.000

.002

.004

.006

.008

2 4 6 8 10 12 14 16 18 20 22 24

of Eto M2

-3

-2

-1

0

1

2

3

2 4 6 8 10 12 14 16 18 20 22 24

of R to M2

-.020

-.015

-.010

-.005

.000

.005

.010

2 4 6 8 10 12 14 16 18 20 22 24

of P to M1

-.02

-.01

.00

.01

.02

.03

.04

2 4 6 8 10 12 14 16 18 20 22 24

of Y to M1

-.004

-.002

.000

.002

.004

.006

.008

2 4 6 8 10 12 14 16 18 20 22 24

of E to M1

-2

-1

0

1

2

3

2 4 6 8 10 12 14 16 18 20 22 24

of R to M1

RO

MA

NIA

Factors that could influence and/or determine opposite responses from the two monetary aggregates.

• Czech National Bank Inflation Report, April 2004,page 8“….the monetary aggregate M1 maintained a growth rate that was supported by low

interest rates, which are giving rise to a long term upward tendency in demand deposits at the expense of time deposits of corporations and households”.

National Bank of Romania, Inflation Report 2/2003, page 42

Identification of Exchange rate shocks(full line – impulse response function; dotted lines – 2 Std.error bands)

-.006

-.004

-.002

.000

.002

.004

2 4 6 8 10 12 14 16 18 20 22 24

of P to E

-.010

-.005

.000

.005

.010

.015

.020

.025

2 4 6 8 10 12 14 16 18 20 22 24

of Y to E

-.6

-.4

-.2

.0

.2

.4

2 4 6 8 10 12 14 16 18 20 22 24

of R to E

-.008

-.004

.000

.004

.008

.012

2 4 6 8 10 12 14 16 18 20 22 24

of M2 to E

CZE

CH

R.

-.004

-.002

.000

.002

.004

2 4 6 8 10 12 14 16 18 20 22 24

of P to E

-.02

-.01

.00

.01

.02

.03

.04

2 4 6 8 10 12 14 16 18 20 22 24

of LY to E

-0.4

0.0

0.4

0.8

2 4 6 8 10 12 14 16 18 20 22 24

of R to E

-.010

-.005

.000

.005

.010

.015

2 4 6 8 10 12 14 16 18 20 22 24

of M2to E

HU

NG

AR

Y

-.006

-.004

-.002

.000

.002

.004

.006

2 4 6 8 10 12 14 16 18 20 22 24

of P to E

-.02

-.01

.00

.01

.02

.03

2 4 6 8 10 12 14 16 18 20 22 24

of Y to E

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2 4 6 8 10 12 14 16 18 20 22 24

of R to E

-.015

-.010

-.005

.000

.005

.010

.015

2 4 6 8 10 12 14 16 18 20 22 24

of M2 to E

PO

LA

ND

-.020

-.015

-.010

-.005

.000

.005

.010

.015

2 4 6 8 10 12 14 16 18 20 22 24

of P to E

-.02

-.01

.00

.01

.02

.03

.04

2 4 6 8 10 12 14 16 18 20 22 24

of Y to E

-3

-2

-1

0

1

2

3

2 4 6 8 10 12 14 16 18 20 22 24

of R to E

-.015

-.010

-.005

.000

.005

.010

.015

2 4 6 8 10 12 14 16 18 20 22 24

of M2 to E

RO

MA

NIA

Variance decomposition and Granger causality testsprices --explain large part of their variance – inflation persistence --procentual variance of P due to E - ~40% at 12 months, in Czech R. and Romania industrial production – explain much of its variance – supply side has its own sources of variation

--still, in Hungary and Poland, R accounts for Y variance at longer horizons

Broad nominal money supply explain ~20% of price variance and (except Czech R.) none of the Y variance

Concluding Remarks

interest rate”price puzzle” in Poland , Czech R. (probably can be reduced if including foreign variables);

a fall in Romanian prices; not significant response for Hungary;

industrial production in Hungary and Poland; no response for Romania and Czech R.

• Mixed evidence about monetary aggregates; greater interest rate elasticity of M1, but, on average, do not seem to be better policy actions indicators than interest rates;

• Exchange rates play an important role in each country; seem to respond to interest rate movements; and conversly, generates interst rate responses;

• Future work must look inside the “black box”;

• The fiscal side must be taken into consideration;

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*****Inflation Report, (2003) third quarter, National Bank of Poland*****Inflation Report (2004), april, Czech National Bank *****Inflation Report 2/2003 National Bank of Romania

*****Quarterly Inflation Report, February 2004, National Bank of Hungary