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Optimal Monetary Policy in the Presence of an Informal Sector and Firm-Level Credit Constraints

Waqas Ahmed, Sajawal Khan () and Muhammad Rehman

MPRA Paper from University Library of Munich, Germany

Abstract: We analyze, in this paper, the optimality of pro-cyclical monetary policy in the presence of informal sector. Our findings suggest that monetary tightening only in case of severe shock with high leverage ratio and that conventional monetary policy favors both the formal and informal sectors irrespective of the severity of the shocks and hence the whole economy if the size of informal sector is significantly large. Furthermore, fixing exchange rate is better policy option if objective is to defend the employment or domestic consumption from falling when negative shock hits the economy. We can not found any disproportionate impact of policies on informal sector. This may be due to static nature of the model and it might be possible that dynamics of responses of the two sectors to shocks differ significantly.

Keywords: Informal Sector; Credit Constraints; Exchange Rate; Monetary Policy (search for similar items in EconPapers)
JEL-codes: E52 F0 F4 O17 O23 (search for similar items in EconPapers)
Date: 2013
New Economics Papers: this item is included in nep-cba, nep-iue, nep-mac and nep-mon
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