Cost Channel of Monetary Policy: Financial Frictions and External Shocks

This paper deepens our understanding of the importance of the cost channel of monetary policy, where inflation adjusts with a firm's marginal cost of working capital. A model extended for a small, open economy with financial frictions is proposed and examined with data from Taiwan. The cost cha...

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Bibliographic Details
Published in:Emerging markets finance & trade 2014-03, Vol.50 (2), p.138-152
Main Authors: Chang, Jui-Chuan Della, Huang, Chen-Jui, Chien, I-Che
Format: Article
Language:English
Subjects:
Capital
Cost
cost channel
external shock
financial friction
Generalized method of moments
Inflation
Interest rates
Monetary policy
Studies
Supply
Taiwan
Working capital
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Summary:This paper deepens our understanding of the importance of the cost channel of monetary policy, where inflation adjusts with a firm's marginal cost of working capital. A model extended for a small, open economy with financial frictions is proposed and examined with data from Taiwan. The cost channel effect on inflation adjustment is substantiated by simultaneous generalized method of moments estimations and appears to be strengthened by financial frictions but mitigated by external shocks. Greater caution is hence required in the conduct of monetary policy for a bank-dependent emerging economy such as Taiwan because of the relative complexity in its supply-side interest rate pass-through.
ISSN:1540-496X
1558-0938
DOI:10.2753/REE1540-496X500208