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Optimal Monetary Policy in the Presence of Sizable Informal Sector and Firm Level Credit Constraint

Waqas Ahmed, Sajawal Khan () and Muhammad Rehman ()
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Muhammad Rehman: State Bank of Pakistan

No 72, SBP Working Paper Series from State Bank of Pakistan, Research Department

Abstract: We analyze optimality of pro-cyclical monetary policy in the presence of informal sector and firm level constraint. Our findings suggest that in case of export demand shock pro-cyclical monetary policy suits only when shock is severe and domestic firms have high leverage ratio. However, the conventional monetary policy helps cushioning the loss in output when the size of informal sector is significantly large. Furthermore, fixing exchange rate is better policy option if objective is to keep domestic employment or consumption from falling (when negative shock hits the economy). We cannot find any disproportionate impact of monetary policy 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 constraint; exchange rate and monetary policy (search for similar items in EconPapers)
JEL-codes: E52 F0 F4 O17 O23 (search for similar items in EconPapers)
Pages: 16 pages
Date: 2016-02
New Economics Papers: this item is included in nep-cba, nep-iue, nep-mac and nep-mon
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