The Impact of Banking Crises on Money Demand and Price Stability
82 Pages Posted: 20 Apr 2016
Date Written: March 2000
Policymakers in countries undergoing banking crises should not worry about the structural stability of money demand functions; the behavior of money demand during crises can be modeled by the same function used during periods of tranquility. But policymakers should be aware that in some instances crises can give rise to variance instability in the price or inflation equations.
Martinez Peria empirically investigates the monetary impact of banking crises in Chile, Colombia, Denmark, Japan, Kenya, Malaysia, and Uruguay. She uses cointegration analysis and error correction modeling to research:
· Whether money demand stability is threatened by banking crises.
· Whether crises bring about structural breaks in the relationship between monetary indicators and prices.
Overall, she finds no systematic evidence that banking crises cause money demand instability. Nor do the results consistently support the notion that the relationship between monetary indicators and prices undergoes structural breaks during crises. However, although individual coefficients in price equations do not seem to be severely affected by crises, crises can sometimes give rise to variance instability in price or inflation equations.
This paper - a product of Finance, Development Research Group - is part of a larger effort in the group to study banking crises. The study was funded by the Bank's Research Support Budget under the research project Monetary Policy and Monetary Indicators during Banking Crises (RPO 683-24). The author may be contacted at email@example.com.
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