External shocks and central banks' policy

Amina Dahleb

Master's thesis

Abstract:

This research focuses on the central bank’s response to external shocks. The purpose of it is to determine which of the monetary policy tools studied is the more effective. It was chosen to study the European Central Bank and the Norges Bank over two periods during which they reacted to major external shocks, the subprime mortgage crisis and the COVID-19 pandemic. Three different types of monetary policy tools that they used in response to these shocks were identified : key interest rates, asset purchase programs and funding for lending program. The effectiveness of these instruments was estimated on the four macroeconomic indicators of the magic square of Kaldor, that is on the inflation, the GDP, the unemployment, and the current account, thanks to a VAR-X model. Then, a Multicriteria Decision Analysis (MCDA) was used to get a ranking of the instruments based on the previous macroeconomic criteria and on criteria related to the implementation of the instruments by central banks. As a result, the policy interest rate is the best instrument available to central banks in response to a shock. Asset purchase programmes are the second effective instrument, ahead of funding for lending programmes. This top ranking for the reduction of the key interest rate is due to its effectiveness regarding macroeconomic criteria. The difficulty of implementing it in zero lower bound situation mitigates this position and highlights the importance for central banks to increase key interest rates during expansion periods to be able to react to a futur external shock.

Keywords

Central banks, Monetary policy, External shock, Monetary policy instrument

Language used: English

Date on which the thesis was submitted / produced: 31. 3. 2022

Thesis defence

• Supervisor: Ing. Karel Malec, Ph.D.

Czech University of Life Sciences Prague

Faculty of Economics and Management

Master programme:
Economics and Management