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Central Bank Lending, Inflation and Output Dynamics in a Limited Participation Model

Author

Listed:
  • Jalali-Naini , Ahmad R.

    (Institute for Management and Planning Studies (IMPS)
    Monetary and Banking Research Institute (MBRI), Central Bank of the Islamic Republic of Iran (CBI))

  • Naderian , Mohammad A.

    (Institute for International Energy Studies (IIES))

Abstract

This paper seeks to evaluate the effects of expansionary monetary policy by the central bank on inflation, output and employment in a limited-participation model for different parameters value of inter-temporal elasticity of substitution and the Frisch (inverse of the labor supply) elasticity. To this end, a modified cash in advance model in line with Lucas (1990), Christiano (1991) and Fuerst (1992) is utilized to account for liquidity effect and anticipated inflation effect simultaneously. The utility function in this model has a CRRA specification in order to perform the sensitivity analysis of the key variables of the model. A range of parameter values for the economy of Iran is used to show the dependency of the results on the size of the coefficient of relative risk aversion and the Frisch elasticity. The simulation results, given the structure and limitation of our model, show that the injection of liquidity to the banking system is inflationary and is not a reliable policy to increase output. We obtained similar results with different parameter values, except for the risk aversion parameter below unity and Frisch elasticity below two. Consistent with prior research, when these parameters are higher, the liquidity effect on output and employment becomes weaker.

Suggested Citation

  • Jalali-Naini , Ahmad R. & Naderian , Mohammad A., 2012. "Central Bank Lending, Inflation and Output Dynamics in a Limited Participation Model," Journal of Money and Economy, Monetary and Banking Research Institute, Central Bank of the Islamic Republic of Iran, vol. 7(1), pages 41-66, October.
    • Handle: RePEc:mbr:jmonec:v:7:y:2012:i:1:p:41-66
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    References listed on IDEAS

    as
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    2. Lawrence J. Christiano & Martin S. Eichenbaum, 1992. "Liquidity effects, the monetary transmission mechanism, and monetary policy," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 16(Nov), pages 2-14.
    3. Cooley, Thomas F & Hansen, Gary D, 1989. "The Inflation Tax in a Real Business Cycle Model," American Economic Review, American Economic Association, vol. 79(4), pages 733-748, September.
    4. Frank Schorfheide, 2000. "Loss function-based evaluation of DSGE models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(6), pages 645-670.
    5. Christiano, Lawrence J & Eichenbaum, Martin, 1992. "Liquidity Effects and the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 82(2), pages 346-353, May.
    6. Shamik Dhar & Stephen P Millard, 2000. "A limited participation model of the monetary transmission mechanism in the United Kingdom," Bank of England working papers 117, Bank of England.
    7. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
    8. Strongin, Steven, 1995. "The identification of monetary policy disturbances explaining the liquidity puzzle," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 463-497, June.
    9. Jalali-Naini , Ahmad R. & Naderian , Mohammad Amin, 2011. "Inflation and Output in a Cash Constrained Economy," Journal of Money and Economy, Monetary and Banking Research Institute, Central Bank of the Islamic Republic of Iran, vol. 6(1), pages 1-28, October.
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    More about this item

    Keywords

    Inflationary policy; Liquidity; Elasticity; Output and employment;
    All these keywords.

    JEL classification:

    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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