An assessment of the dynamic effects of monetary policy in Macedonia

ABSTRACT

Macedonia, as a small emerging economy, is exposed to foreign risks such as: exchange rate volatility, trade distortions, and highly volatile capital flows. To ‘protect’ its economy, since 1995, the Macedonian Central Bank has applied the monetary strategy of exchange rate targeting, where the interest rate on Central Bank bills auctions is a basic monetary-policy instrument. This paper re-examined the effectiveness of the current monetary policy in Macedonia using the policy-oriented vector error correction model (VECM). We found that the Macedonian Central Bank demonstrates a low level of monetary-policy effectiveness and the existing monetary-policy strategy does not necessarily promote its ability to react countercyclically.

KEYWORDS:

• VECM
• cointegration
• monetary-policy effectiveness
• Macedonia

JEL CLASSIFICATION:

• C32
• E50
• E52

Acknowledgments

I wish to record my gratefulness to Ansgar Belke (University of Duisburg Essen) and Goran Petrevski (St. Cyril and Methodius University Skopje) for valuable and useful comments.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ The test of serial correlation has proven that the chosen number of lags is quite sufficient to ‘cover’ the dynamics of the model.

² Since the ‘inflation variable’ is weakly exogenous, we imposed restrictions on its long-run parameters. We did the same with the long-run parameter of the ‘interest rate variable’ in the first error correction vector.

³ Since Cholesky’s decomposition is sensitive to the ordering of variables, we re-estimated our model using a new vector of endogenous variables: $x_t={\left[y_{t}Cbbill{s}_{t}cp{i}_{t}m{1}_t\right]}^{\prime }$. Our main conclusions remained unaltered. These results are available upon request.

⁴ In this respect, our results are in line with Brand, Reimers, and Seitz (2003).

⁵ It would be much more ‘acceptable’ for the interest rates to absorb the predictive power of monetary aggregates, which would imply a direct transmission of the monetary policy real effects through interest rates rather than through monetary aggregates.