Monetary policy in practice: do central banks respond to movements in exchange rate and credit growth?

Hai Le and Phuong Nguyen

Journal of Economic Studies, 2023, vol. 51, issue 6, 1322-1354

Abstract: Purpose - This study examines the importance of exchange rate and credit growth fluctuations when designing monetary policy in Thailand. To this end, the authors construct a small open economy New Keynesian dynamic stochastic general equilibrium (DSGE) model. The model encompasses several essential characteristics, including incomplete financial markets, incomplete exchange rate pass-through, deviations from the law of one price and a banking sector. The authors consider generalized Taylor rules, in which policymakers adjust policy rates in response to output, inflation, credit growth and exchange rate fluctuations. The marginal likelihoods are then employed to investigate whether the central bank responds to fluctuations in the exchange rate and credit growth. Design/methodology/approach - This study constructs a small open economy DSGE model and then estimates the model using Bayesian methods. Findings - The authors demonstrate that the monetary authority does target exchange rates, whereas there is no evidence in favor of incorporating credit growth into the policy rules. These findings survive various robustness checks. Furthermore, the authors demonstrate that domestic shocks contribute significantly to domestic business cycles. Although the terms of trade shock plays a minor role in business cycles, it explains the most significant proportion of exchange rate fluctuations, followed by the country risk premium shock. Originality/value - This study is the first attempt at exploring the relevance of exchange rate and credit growth fluctuations when designing monetary policy in Thailand.

Keywords: Credit growth; Exchange rates; Monetary policy; DSGE modeling; Small open economy models; Bayesian estimation; E12; E32; E44; E52; F31; F41 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jespps:jes-05-2023-0258

DOI: 10.1108/JES-05-2023-0258

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