Essays in monetary policy and banking

This dissertation explores several aspects of the relationship between monetary policy and banking sector conditions. The first essay explores the nature of the Taylor-type monetary policy rules. It begins by noting that efforts to empirically fit the variants of Taylor's original rule to past policy must account for a hitherto unacknowledged factor in the conduct of monetary policy: the soundness of the banking sector. The empirical results of this essay suggest that proxies for banking sector solvency are, amongst other variables, a reliable predictor of the path of monetary policy over the 1980–1999 period. Therefore, adopting a monetary policy rule that does not take into account this factor will represent a significant departure from recent management of monetary policy.; The second essay explores the usefulness of conducting supervisory bank examinations. It surveys recent empirical literature to look at this issue from two perspectives: (1) potential contribution of supervisory bank data to macroeconomic forecasts and (2) the adoption by the government of a more market-oriented approach to bank supervision. The reviewed studies suggest that while supervisory data are of limited use for central bank forecasts of inflation and unemployment, it is still possible that such information may be helpful to private forecasters. In addition, it appears that markets correctly assess changes in bank financial conditions, and that government oversight generates little additional information beyond already existing public knowledge.; The final essay of this dissertation reexamines the relationship between short term interest rates and bank profitability. It uses modern dynamic panel-data methods to test the widespread notion that commercial banks “borrow short and lend long”. Such a notion implies that market rate increases are negatively correlated with bank profits. The empirical results presented in this chapter indicate that commercial bank profits are positively correlated with interest rates, though the magnitude of this correlation is not economically large. Also, there is no evidence that interest rate volatility adversely affects bank profits.