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The effectiveness of monetary policy in small open economies

Author

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  • Primus, Keyra
Abstract
This paper examines the relative effectiveness of the use of direct and indirect monetary policy instruments in Barbados, Jamaica and Trinidad and Tobago, by estimating a restricted Vector Autoregressive model with Exogenous Variables (VARX). The model captures the dynamic interaction of the key sectors in the economy and it accounts for the fact that the banking system in those countries is characterized by high levels of excess reserves. Also, the study assumes that the central bank conducts monetary policy using a Taylor-type rule, and it evaluates the effects of a reserve requirement policy. The results show that although a positive shock to the policy interest rate has a direct effect on commercial banks’ interest rates, there is a weak transmission to the real variables. Furthermore, an increase in the required reserve ratio is successful in reducing private sector credit and excess reserves, while at the same time alleviating pressures on the exchange rate. The findings therefore indicate that central banks in small open economies should consider using reserve requirements as a complement to interest rate policy, to achieve their macroeconomic objectives.

Suggested Citation

  • Primus, Keyra, 2018. "The effectiveness of monetary policy in small open economies," Journal of Policy Modeling, Elsevier, vol. 40(5), pages 903-933.
    • Handle: RePEc:eee:jpolmo:v:40:y:2018:i:5:p:903-933
    DOI: 10.1016/j.jpolmod.2018.03.001
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    References listed on IDEAS

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    1. Keyra Primus & Anthony Birchwood & Lester Henry, 2014. "The Dynamics of Involuntary Commercial Banks Reserves in Trinidad and Tobago," Journal of Developing Areas, Tennessee State University, College of Business, vol. 48(2), pages 63-84, April-Jun.
    2. Roland Craigwell & Kevin Greenidge & Harold Codrington & Mr. Rupert D Worrell, 2003. "Economic Resilience with An Exchange Rate Peg: The Barbados Experience, 1985-2000," IMF Working Papers 2003/168, International Monetary Fund.
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    6. Carl E. Walsh, 2010. "Monetary Theory and Policy, Third Edition," MIT Press Books, The MIT Press, edition 3, volume 1, number 0262013770, April.
    7. Primus, Keyra, 2017. "Excess reserves, monetary policy and financial volatility," Journal of Banking & Finance, Elsevier, vol. 74(C), pages 153-168.
    8. Lütkepohl,Helmut & Krätzig,Markus (ed.), 2004. "Applied Time Series Econometrics," Cambridge Books, Cambridge University Press, number 9780521547871, September.
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    16. Khemraj, Tarron, 2007. "Monetary policy and excess liquidity: the case of Guyana," MPRA Paper 53126, University Library of Munich, Germany.
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    22. Tarron Khemraj, 2009. "Excess liquidity and the foreign currency constraint: the case of monetary management in Guyana," Applied Economics, Taylor & Francis Journals, vol. 41(16), pages 2073-2084.
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    More about this item

    Keywords

    Reserve requirements; Macroeconometric model; Small open economies;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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