Monetary Policy in a World with Different Financial Systems

51 Pages Posted: 17 May 2003

See all articles by Ester Faia

Ester Faia

Goethe University Frankfurt; Centre for Economic Policy Research (CEPR)

Date Written: October 2002

Abstract

Major currency areas are characterized by important differences in financial structure that are clear in microeconomic data. Surprisingly, this fact is seldom discussed in the analysis of the international transmission of shocks. This paper attempts to fill this gap. First, I show some stylized facts about financial differences and cyclical correlations. Second, using a two-country, calibrated to US and euro area data, I analyze the international transmission of shocks with different degrees of financial fragility in the two economies. I find, first, that financial diversity accounts for heterogenous business cycle fluctuations. Differential responses occur with independent monetary policies even with low degrees of economic and financial openness. Credible pegs help to increase the synchronization of cycles. Secondly, differences in persistence of the interest rates help to explain high persistence in the real exchange rate. Finally, weak financial systems can result in large welfare losses under symmetric and correlated shock.

Keywords: Financial diversity, monetary regimes, differential transmission mechanism, financial stability, welfare losses

JEL Classification: E3, E42, E44, E52, F41

Suggested Citation

Faia, Ester, Monetary Policy in a World with Different Financial Systems (October 2002). Available at SSRN: https://ssrn.com/abstract=358242

Ester Faia (Contact Author)

Goethe University Frankfurt ( email )

Gr├╝neburgplatz 1
Frankfurt am Main, 60323
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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