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Improving the Monetary Policy Frameworks in Central America
Several Central American (CADR) countries with independent monetary policies are strengthening their monetary frameworks and some have implemented or are moving towards inflation targeting (IT) regimes. Strengthening the monetary policy frameworks of CADR is key to improving the effectiveness of monetary policy. The paper reviews the literature on the reforms needed for strengthening the monetary policy frameworks, and examines the experiences of IT countries, Chile, Peru, and Uruguay to help distill lessons for CADR. It also constructs an index to measure the relative strength of the monetary policy framework of CADR countries.
The Policy Interest-Rate Pass-Through in Central America
Several Central American (CADR) central banks with independent monetary policies have adopted policy interest rates as their main instrument to signal their monetary policy stances, often in the context of adopting or transitioning to inflation targeting regimes. This paper finds that the interest-rate transmission mechanism, or the pass-through of the policy rate to market rates, is generally weaker and slower in CADR than in the LA6, the countries selected as benchmarks. A variety of potential factors behind this finding are examined, including the degrees of financial dollarization, exchange rate flexibility, bank concentration, financial sector development, and fiscal dominance. Through panel data analysis, the study suggests that the transmission mechanism can be strengthened by increasing exchange rate flexibility, and, over time, by adopting measures towards reducing financial dollarization, developing the financial sector, and reducing bank concentration.
Central Bank Financial Strength in Central America and the Dominican Republic
This paper examines the financial strength of central banks in Central America and the Dominican Republic (CADR). Some central banks are working off the effects of intervention in distressed financial institutions during the 1990’s and early 2000’s. Their net income has improved since then owing to lower interest rates, a reduction in interest bearing debt, and recapitalization transfers. Claims on the government have fallen, but remain high and are typically reimbursed at below-market rates, and capital is negative when adjusting for this. Capital is sufficient to back a low inflation target given that the income position is supported by unremunerated reserve requirements. Capital is likely to increase over time, but only gradually, leaving countries vulnerable to macroeconomic risks. The capacity of CADR central banks to engage in macroeconomic stabilization would benefit from increased emphasis on low inflation as the primary objective of monetary policy and a stronger commitment by governments to recapitalization.
Do Central Banks Need Capital?
Central banks may operate perfectly well without capital as conventionally defined. A large negative net worth, however, is likely to compromise central bank independence and interfere with its ability to attain policy objectives. If society values an independent central bank capable of effectively implementing monetary policy, recapitalization may become essential. Proper accounting practice in determining central bank profit or loss and rules governing the transfer of the central bank’s operating result to the treasury are also important. A variety of country-specific central bank practices are reviewed to support the argument.
Sophie's Fire
In the midst of a raging fire on a winter night in 1779, a Burgundian woman went into early labor and delivered a child who never should have survived. Instead, the tiny infant-Madeleine Sophie Barat-went on to thrive in a France wracked and torn by revolution, terror, Napoleonic domination, and all that followed in their wake. Possessed of a vision of a world dedicated to generosity and love, she founded a religious order and an international network of schools that still flourish today: the schools of the Sacred Heart. In 1925 she was declared a saint. Passionate, brilliant, politically savvy, and aware of the powerful potential of women to reshape society, Sophie is a role model for our o...
Financial Structure, Bank Lending Rates, and the Transmission Mechanism of Monetary Policy
The stickiness of bank lending rates with respect to money market rates is often regarded as an obstacle to the smooth transmission of monetary policy impulses. Yet, no systematic measure of the different degree of lending rate stickiness across countries has been attempted. This paper provides such a measure. It also relates the different degree of lending rate stickiness to structural features of the financial system, such as the existence of barriers to competition, the degree of development of financial markets, and the ownership structure of the banking system. Thus, the paper provides further evidence on the relationship between structural financial policies and monetary policy, as well as on the relevance of credit markets for the monetary policy transmission mechanism. The role of administered discount rates in speeding up the. adjustment of lending rates is also discussed.
Does Central Bank Capital Matter for Monetary Policy?
Heavy foreign exchange intervention by central banks of emerging markets have lead to sizeable expansions of their balance sheets in recent years?accumulating foreign assets and non-money domestic liabilities (the latter due to sterilization operations). With domestic liabilities being mostly of short-term maturity and denominated in local currency, movements in domestic monetary policy interest rates can have sizable effects on central bank's net worth. In this paper we examine empirically whether balance sheet considerations influence the conduct of monetary policy. Our methodology involves the estimation of interest rate rules for a sample of 41 countries and testing whether deviations from the rule can be explained by a measure of central bank financial strength. Our findings, using linear and nonlinear techniques, suggests that central bank financial strength can be a statistically significant factor explaining large negative interest rate deviations from "optimal" levels.
