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How does financial liberalisation affect the influence of monetary policy on the current account?

Ida Hjortsoe, Martin Weale and Tomasz Wieladek

Journal of International Money and Finance, 2018, vol. 85, issue C, 93-123

Abstract: Does the current account improve or deteriorate following a monetary policy expansion? We examine this issue theoretically and empirically. We show that a standard open economy DSGE model predicts that the current account response to a monetary policy shock depends on the degree of financial regulation. In particular, financial liberalisation makes it more likely that the current account deteriorates following a monetary expansion. We test this theoretical prediction with a varying coefficient Bayesian panel VAR model, where the coefficients are allowed to vary as a function of the degree of financial, product and labour market regulation on data from 1976Q1-2006Q4 for 19 OECD countries. Our empirical results support the theory. We therefore conclude that following a monetary policy expansion, the current account is more likely to go into deficit in countries with more liberalised financial markets.

Keywords: Balance of payments; Current account; Bayesian panel VAR; Economic regulation; Monetary policy (search for similar items in EconPapers)
JEL-codes: F32 E52 C11 C23 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:jimfin:v:85:y:2018:i:c:p:93-123