Remittances, Monetary Policy, and Partial Sterilization

Abstract

Remittances play a large and important role in certain economies, where they became a significant share of GDP. Official government records of these flows have been systematically improved since governments realized their importance, but a significant percentage of remittances remain unrecorded. This, together with the shadow economy, may pose a problem for monetary policy. This article uses a limited participation model to examine the differential effect that higher shares of remittances can have on monetary policy and describes the impact of remittances on a small open economy under partial sterilization. It demonstrates how a typical monetary shock will lead to a more pronounced liquidity effect when remittances become a higher proportion of GDP. It also shows that a positive remittance shock improves consumption and lowers interest rates, but as it also reduces work effort it momentarily lowers output. Such dynamics are exacerbated as the degree of partial sterilization is accentuated.

The Macroeconomic Consequences of Remittances

“…An increase in remittances creates inflationary pressure in our model, as that found by Narayan et al [2], Vacaflores [3], and Mandelman [12]. In terms of the interest rate response, Giuliano and Ruiz-Arranz [30] provide evidence of the beneficial effect that remittances have in alleviating liquidity constraints, and Aggarwal et al [31] show that remittances have a positive impact on financial sector development.…”

“…Narayan et al [2] confirm this effect in a set of 54 developing countries for the period 1995-2004, showing that remittances generate inflationary pressures, which becomes accentuated in the long run. Vacaflores [3] uses quarterly data and also finds that increases in remittances led to increases in inflation for a set of 11 Latin American countries in the last 15 years. The finding in Vacaflores et al [13] showing that remittances contribute to the accumulation of international reserves in Latin America also suggests a positive impact on inflation.…”

“…Vacaflores [3] unveils a differential impact from remittances shocks in economies with different degrees of sterilization, showing that partial sterilization gives rise to a more pronounced drop in the interest rate, and that the labor-leisure tradeoff is exacerbated due to indirect effects on the money growth and inflation. Similar in spirit but with an opposite outcome, the study of Mandelman [12] finds that a positive remittances shock generates inflation that is controlled by the monetary authority through a contraction of the money supply-a rise in the interest rate.…”

“…While recent research has shed some light on their potential influence on consumption and inflation (Narayan et al [2] and Vacaflores [3]), on the exchange rate and trade competitiveness (Amuedo-Dorantes and Pozo [4] and Acosta et al [5]), on labor supply (Funkhouser [6], Hanson [7], Chami et al [8], Acosta et al [5] and Jansen and Vacaflores [9]), on economic growth (Cáceres and Saca [10] and Osili [11]), and on policy responses (Chami et al [8], Mandelman [12] and Vacaflores [3]), little attention has been placed on the potentially different effect that remittances shocks can have on the main macroeconomic aggregates depending on the distribution of remittances between consumption and investment, on the relative importance of remittances as a share of GDP, and on its relative importance in terms of income.…”

Remittances, Dutch Disease, and Manufacturing Growth in Developing Economies

“…This tends to occur in fixed-exchange-rate regime. See, for instance,Vacaflores (2012) andMandelman (2013).…”