We estimate a flexible non‐linear monetary policy rule for the United Kingdom to examine the response of policymakers to the real exchange rate. We have three main findings. First, policymakers respond to real exchange rate misalignment rather than to the real exchange rate itself. Second, policymakers ignore small deviations of the exchange rate; they only respond to real exchange under‐valuations of more than 4% and over‐valuations of more than 5%. Third, the response of policymakers to inflation is smaller when the exchange rate is over‐valued and larger when it is under‐valued. None of these responses is allowed for in the widely used linear Taylor‐type rules, suggesting that monetary policy is better analysed using a more sophisticated model, such as the one suggested in this paper.
This paper develops a macroeconomic forecasting model focusing on fiscal policy and economic growth in Nepal. The structure of the model, which comprises a total of 14 equations, allows alternative policy options for maintaining fiscal stability and promoting economic growth as well as switching deficit financing between domestic and foreign loans. We use annual data from 1992/93 to 2009/10 to estimate the model and provide out-sample forecasts for 2010/11 to 2012/13, consistent with the current Three Year Plan period, in order to evaluate the plan performance. The empirical evidence suggests that fiscal policy, particularly governments' capital expenditure affects economic growth positively and also crowds-in private investment. However, there exists a trade-off between fiscal stability and high level of economic growth as the policy goal of achieving both objectives seems to be unattainable. Finally, the out-sample forecast suggests that it is unlikely to attain the targeted economic growth in the Three Year Plan period from the planned fiscal outlay even if it is realized.
Despite causality debate, a number of empirical literatures (Pagano, 1993 and Levine, 1997, among others) suggest a positive relationship between financial sector development and economic growth. Moreover, there remains further debate whether the country's financial structure exerts differential impact on economic growth. Empirical studies across the countries (Rajan and Zingales, 1999 and Arestis et. al. 2004) suggest that banking sector plays a key role in some countries while the capital market has a lead position in others for enhancing economic growth. In this context, this paper investigates the relative merits of banking sector vs. capital market in promoting economic growth in Nepal. The empirical results using Johansen's cointegrating vector error correction model based on aggregate annual data from 1993/9 to 2010/11 suggest that banking sector plays a key role in promoting economic growth compared to capital market in Nepal. It may be either the size of capital market is too small to seek the relationship or it is weakly linked to real economic activities. Our result implies that the policy should focus on banking sector development by enhancing its quality and outreach as it promotes economic growth in Nepal.
There is a large volume of literature documenting the analysis of spatial market integration based on individual commodity prices. This paper, instead, contributes to the literature by delineating the existence of spatial market integration using intra-regional price indices. In this context, we use monthly price indices for Kathmandu valley, Hill and the Terai region, which are the only available spatial indices in Nepal. Employing Johansens' bi-variate cointegrating approach for the period from August 1995 to December 2010, we found a strong proposition of Law of One Price (LOP) across the region indicating the fact that spatial markets are highly integrated albeit speed of adjustment is rather slow. This may be due to the existence of oligopolistic pricing behaviour, carteling, asymmetric market information, and syndicate in the transportation system as discussed in various literatures.
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