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Monetary policy in a Model with Commodity and Financial Markets

Vo Phuong Mai Le () and Ruthira Naraidoo ()
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Vo Phuong Mai Le: Cardiff Business School, Aberconway Building, Cardiff University, Colum Drive, Cardiff, Wales, United Kingdom, CF 10 3EU

No 201928, Working Papers from University of Pretoria, Department of Economics

Abstract: This paper builds a small open economy model for a net commodity exporter to consider financial frictions and monetary policies in order to investigate the main determinants of business cycles. Since we make a distinction to the access of financial markets between the commodity and non-commodity sectors, we notice that as usual, a commodity price shock benefits the competitiveness of the economy and its borrowing terms. We outline a novel effect in this paper which we dub the “financial market effect” following a positive commodity price shock that decreases the credit premium and hence exacerbate the commodity price boom. However, the negative sectoral downturn affects entrepreneur credit together with disinflationary pressures of a real exchange rate appreciation. This opens the role for stabilization policies which we analyze comparing three types of monetary regimes. Estimating the model on South Africa, a major commodity exporting economy with inflation targeting regime, we find as conventional wisdom suggests that a hypothetical Taylor rule targeting the price-level allows for adjustment in inflation expectations that can dampen disinflationary pressures. Furthermore, due to smoother change in nominal rate of interest, there is lesser variability in financial markets.

Keywords: Business cycles; Small open economy; Commodity prices; Financial frictions; Emerging markets; Monetary policy; Price-level targeting; South Africa economy (search for similar items in EconPapers)
JEL-codes: E32 E44 E58 F41 F44 O16 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2019-03
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-opm
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