MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HO CHI MINH CITY HO THI LAM FINANCIAL DEVELOPMENT AND THE EFFECTIVENESS OF MONETARY POLICY Major: Finance – Banking Major code: 93 40201 SUMMARY OF PHD THESIS HO CHI MINH CITY - 2019 The thesis is completed at: University of Economics Ho Chi Minh City Supervisor: Prof Dr Tran Ngoc Tho Contradicteur 1: ………………………………………… ………………………………………………………… Contradicteur 2: ………………………………………… …………………………………………………………… Contradicteur 3: ………………………………………… …………………………………………………………… The thesis will be defensed in front of the Academic Council convened by ……………………………… …………………………………………………………… At … … … … … This thesis can be found at the library: …………………… ………………………………………………………… …………………………………………………………… …………………………………………………………… CHAPTER – INTRODUCTION 1.1 Introduction While the relationship between financial development, capital accumulation and economic growth is clear and gets concerned by numerous researches, the impact of monetary policy on a real economy with the role of financial system seems limited Financial globalization and integration of financial markets in different countries have increased the complication in the environment where national monetary agencies operate The appearance of new types of currencies, payment technologies or substitute financial assets makes it more difficult to determine money aggregates Central Banks’ monetary control also becomes hard to solve Financial development has changed both monetary supply and demand, causing policy makers to encounter obstacles with respect to ability to control capital flows, manage liquidity, maintain sustainability of exchange rates and avoid booming cycles in asset markets From the perspective of monetary policy, it is worth studying a question of how such financial development affects the way that Central Banks implement policies and that such policies are transmitted to the economies However, there is little evidence of the effects that the financial development puts on the effectiveness of the monetary policy in the current period of time Although there are some authors doing research on the same topic, they still encounter some pending issues First, the measurement of the Monetary Policy Effectiveness has not covered all the objectives of the monetary policy of Central Banks (Ma & Lin, 2016, Carranza, Galdon-sanchez & Gomezbiscarri, 2010) Second, they have not paid attention to factors affecting the monetary policy effectiveness (Cecchetti, FloresLagunes & Krause, 2006; Olson & Enders, 2012; Olson, Enders & Wohar, 2012) Third, they have only considered role of some certain aspects of the concept of the financial development on the effectiveness of monetary policy (Akhtar, 1983; De Bondt, 1999; Cecchetti & Krause, 2001, 2002; Georgiadis & Mehl, 2016; Bernoth, Gebauer & Schäfer, 2017) without considering the whole role of the financial development Starting from both academic and practical perspectives, it is necessary to research on the monetary policy effectiveness and the impact of the financial development on the monetary policy effectiveness in order to overcome limitations of previous researches, aiming at producing scientific understandings on the management of the monetary policy in new context 1.2 Objectives Evaluate impacts of the financial development on the monetary policy effectiveness Specific objectives are: Firstly, testing the Taylor curve theory; secondly, developing and establishing the efficient frontier of the monetary policy for countries on the basis of the Taylor curve theory and measures the monetary policy effectiveness; thirdly, studying the effects of the financial development (with respect to various aspects) on the effectiveness of the monetary policy in the countries of the research sample 1.3 Research questions 1.4 Subject and Scope of study This research studiesthe impact of the financial development on the monetary policy effectiveness in G-7 developed countries (including Canada, France, Germany, Italy, Japan, United Kingdom, and United State) from 1951 to 2017 (depending on the data availability) 1.5 Methodologies and data 1.6 Contributions 1.7 Thesis’s structure CHAPTER – THEORETICAL FRAMEWORK AND LITERATURE DEVELOPMENT REVIEW AND OF MONETARY FINANCIAL POLICY EFFECTIVENESS 2.1 Monetary Policy 2.2 Monetary Policy Effectiveness and Taylor Curve Theory 2.2.1 Taylor Curve Theory The Taylor curve theory describes permanent trade-off between output volatility and inflation volatility in implementing the monetary policy (Taylor, 1979), and it is an important guiding principle in many studies on the monetary policy (see more, Taylor, 1994; Fuhrer, 1997; Orphanides et al., 1997; Chatterjee, 2002; Taylor & Williams, 2011; Olson, Enders & Wohar, 2012) The Taylor curve is considered as the efficient frontier of the monetary policy, showing the position on which the monetary policy is optimal towards the inflation volatility and the output is at lowest level corresponding to central bank’s taste with regards to whether price stability or business cycle stability is prioritized (Taylor, 1979; Friedman, 2010) Basic principle of the Taylor curve is based on Central Bank’s optimizing behavior in implementing monetary policy to minimize loss to the economy against unexpected effects of shocks Loss function measuring weighted total costs of inflation volatility and output volatility against their target levels: ℒ = 𝐸[𝜆(𝜋 − 𝜋 ∗ )2 + (1 − 𝜆)(𝑦 − 𝑦 ∗ )2 ] (2.2) Where 𝜆 is the central bank’s preference for inflation stability (0 ≤ 𝜆 ≤ 1) So as to minimize loss, the central bank has to determine factors which determine the deviation between real output and inflation against their targets A simple economy is affected by two types of shocks – aggregate demand shock (d) and aggregate supply shock (s) and these two types require policy response The aggregate demand shock causes output and inflation change in the same direction and aggregate supply shock causes in opposite direction Because monetary policy can affect output and inflation in the same direction, it can completely offset the effect of the aggregate demand shock In contrast, the aggregate supply shock will require monetary agencies to encounter a trade-off between output volatility and inflation volatility (Taylor, 1979, Output volatility (σy) Clarida, Galí & Gertler, 1999; Cecchetti & Krause, 2001) Efficient Frontier Inflation volatility (σπ) Fig 2.1 The Taylor curve The trade-off relationship is modeled by a downward sloping curve, convex to the origin on a two-dimensional graph (output volatility – inflation volatility) The efficient frontier of monetary policy traces points at which the inflation volatility cannot be achieved at lowest level without causing any increase in the output volatility (Taylor, 1979; Cecchetti, FloresLagunes & Krause, 2006) This efficient frontier is called Taylor curve (Taylor, 1994; King, 1999; Bernanke, 2004; Friedman, 2010; Olson & Enders, 2012) Figure 2.1 illustrates the efficient frontier of monetary policy according to Taylor (1979) If the monetary policy is optimal, the economy will be on this curve When the policy is below optimal level, the economy will not be on this curve Instead, the efficient point will be above on the right side with the fact that the inflation volatility goes beyond other feasible points Movements of the efficient points to the frontier signal that the policy effectiveness is improved 2.2.2 Monetary Policy Effectiveness The monetary policy effectiveness is the capability of central banks to achieve their objectives, stabilize impacts of the shocks on the economy and reduce macroeconomic volatility by implementing monetary policy with available instruments (Boivin & Giannoni, 2006, Cecchetti & Krause, 2001, Cecchetti et al., 2006, Mishkin & Schmidt-Hebbel, 2007, Taylor, 1979) 2.2.3 Factors affecting the effectiveness of monetary policy 2.3 Financial Development 2.3.1 Role of financial system in monetary transmission mechanism 2.3.2 Financial Development Financial development includes improvement in the functions of financial system such as (i) aggregating savings; (ii) appropriating capital for production; (iii) monitoring such investments; (iv) diversifying risks; and (v) exchanging goods and services (Levine, 2005) Financial development involves in competitive and efficient issues in the financial sector; scope of services provided; variety of financial institutions in the financial sector; volume of credit granted by financial intermediaries along with the right to access financial services and financial stability (Svirydzenka, 2016) 2.3.3 Measuring Financial Development The best way to measure financial development is to measure the degree to which five functions of the financial system are improved However, it is a great challenge to have a direct measurement for the functions Levine (2005) pointed out that such empirical variables not normally measure exactly concepts coming from theoretical models Many studies on the financial development towards economic growth; inequality or poverty and economic stability have developed different measures for the financial development (Svirydzenka, 2016) Some studies focus on the development in banking sector, some others focus on the development in stock market, whereas the others compile them in an indicator 2.4 Theory of the impacts of the financial development on the monetary policy effectiveness Theory of the impacts of the financial development on the monetary policy effectiveness has been developed very early with different aspects on money supply, money demand and monetary transmission mechanism (see Gurley & Shaw, 1955, 1967; Vanhoose, 1985; Lown, 1987; Taylor, 1987; Modigliani & Papademos, 1989; Hendry & Ericsson, 1991; Arestis, Hadjimatheou & Zis, 1992, etc.) 2.4.1 Impacts of the financial development on money supply control The financial development makes it more difficult to determine money aggregates Characteristics of the financial development such as the continuous appearance of new instruments and products make the determination and differentiation of “moneyness” and “liquidity” of the instruments becomes inaccurate, and thus, it is difficult to define which instrument to be included in money aggregates Simultaneously, the appearance of non-cash payment methods and electronic money types put impact on the velocity of money circulation, making it difficult for central banks to control money supply (Akhtar, 1983; Singh et al., 2008) 2.4.2 Impacts of the financial development on money demand The appearance of financial instruments with floating interest rate, along with the development of non-cash payment methods, etc in a developed financial system cause the elasticity of money demand to interest rate to change, long-run money demand to reduce whereas it is hard to predict short-run change Accordingly, money demand function is not stable over time, thus, the size of money demand becomes difficult to be estimated Regarding IS-LM procedure, the LM curve becomes more sloping and more difficult to position (Akhtar, 1983) 2.4.3 Impacts of Financial Development on monetary transmission mechanism The monetary transmission mechanism can be modeled into phases as can be seen from Figure 2.3 Figure 2.3 Factors impacting monetary policy transmission mechanism Source: Loayza & Schmidt-Hebbel (2002) First phase: any change in monetary policy will be transmitted to change in market interest rate and price of other financs output, 𝜋 is inflation, i is interest rate and oil is oil price, with removal of trends Ht is a matrix of variance – covariance, 𝜈𝑡 is a white noise process Based on Lee (1999, 2002, 2004); Olson et al (2012), the assumption of the trade-off relationship between output volatility and inflation volatility is tested with the bivariate GARCH– BEKK model, as discussed by Engle & Kroner (1995) In particular, I keep track with dynamic behaviors of inflation volatility and output volatility which are unable to be directly observed with the estimation of conditional variance of inflation and output in accordance with the structure model of (3.1), (3.2) The relationship between ℎ11,𝑡 and ℎ22,𝑡 is center of the Taylor curve relationship The assumption of the trade-off relationship between output volatility and inflation volatility is tested by testing signs of elements of 𝑏12 and 𝑏21 of B matrix If these elements have negative signs, the Taylor curve theory is determined The lag of independent variables in the mean equation is selected on the basis of testing F with the estimation (3.1) (3.2) (3.6) 15 𝑛 𝑦𝑡 = ∑ 𝛼1,𝑗 𝑦𝑡−𝑗 𝑗=1 𝑛 +∑ 𝑛 𝛼1,(𝑗+𝑛) 𝜋𝑡−𝑗 + 𝑗=1 ∑ 𝛼1,(𝑗+2𝑛) 𝑖𝑡−𝑗 + 𝛼1,(3𝑛+1) 𝑜𝑖𝑙𝑡−1 𝑛 + 𝜀𝑗=1 1,𝑡 𝜋𝑡 = ∑ 𝛼2,𝑗 𝑦𝑡−𝑗 𝑗=1 (4.1) 𝑛 + ∑ 𝛼2,(𝑗+𝑛) 𝜋𝑡−𝑗 + 𝛼2,(2𝑛+1) 𝑜𝑖𝑙𝑡−1 + (4.2) 𝑗=1 𝜀2,𝑡 The optimal lag is selected in accordance with Schwarz information criterion (SBC) 4.2.1.2 Developing the Taylor curve After estimating the structural model for each country, I use estimate parameters to develop the efficient frontier As described in Chapter 2, I develop the efficient frontier by minimizing the loss function (2.2) in accordance with constraints imposed by the economy’s dynamic structure Equation (4.1) and (4.2) is represented in the form of state space as follows: 𝐘𝑡 = 𝐁𝐘𝑡−1 + 𝐜𝑖𝑡−1 + 𝐃𝑋𝑡−1 + 𝒗𝑡 (4.3) In the form of matrix, loss function (2.2) is: 𝐘𝑡 ′ Λ𝐘𝑡 (4.4) Accordingly, 𝐁 and 𝐃 are matrices of estimate parameters for aggregate supply and aggregate demand models Λ is the weighted matrix attributed to inflation and output volatility The problem of policy makers is to choose an interest rate to minimize (4.4), subject to constraints imposed by (4.3) Given the quadratic nature of the loss function, the solution for the interest rate will be linear (Cecchetti et al., 2006; Mishkin & Schmidt-Hebbel, 2007), which is written as: 16 𝑖𝑡 = 𝐠𝐘𝑡 + Ψ (4.5) In particular 𝐠 is a vector of central bank’s response factors to the change in inflation and output and Ψ is constant term subject to 𝐁, 𝐜, 𝐃 and target value of inflation and output The equation (4.5) represents an unrestricted monetary policy rule, in which the degree of interest rate persistence can be observed by 𝑖𝑡−1 which is a component of 𝐘𝑡 (Rudebusch & Svensson, 1999; Cecchetti et al., 2006) The control problem is solved by finding 𝐠 such that: 𝐠 = −(𝐜 ′ 𝐇𝐜)−𝟏 𝐜 ′ 𝐇𝐁 (4.6) In which, 𝐇 is the solution to the equation: 𝐇 = 𝚲 + (𝐁 + 𝐜𝐠)′ 𝐇(𝐁 + 𝐜𝐠) (4.7) With estimate values of parameters in 𝐁 and 𝐜, we can come to the solution for 𝐇 and 𝐠 for any value of 𝜆 From the results of the equations above, the optimal variance value of output and inflation can be calculated one point on the Taylor curve, which corresponds to one value of given 𝜆, can be obtained By repeating the procedure using different values of 𝜆 in the scale of [0; 1], the whole Taylor curve can be found With this estimated efficient frontier, I calculate minimum orthogonal distance between observed fluctuations and their optimal values on the Taylor curve to represent the monetary policy effectiveness 4.2.2 Data The data are used as described in Chapter 4.3 Results and Discussion 4.3.1 Taylor curve estimated 4.3.2 Monetary policy effectiveness over time 17 Figure 4.2 demonstrates the effectiveness of monetary policy changes over time in countries The monetary policy effectiveness is measured by the orthogonal distance from the point of inflation fluctuation and observed actual output to the Taylor curve of each country respectively Accordingly, the greater the orthogonal distance is, the less effective monetary policy is because the economy is farther from the point of optimal efficiency Minimum Distance of Observed Volatilities from Taylor Curve of Canada Minimum Distance of Observed Volatilities from Taylor Curve of US 0.8 0.7 0.7 0.6 0.6 0.5 0.5 0.4 0.4 0.3 0.3 0.2 0.2 0.1 0.1 0.0 0.0 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 Minimum Distance of Observed Volatilities from Taylor Curve of France Minimum Distance of Observed Volatilities from Taylor Curve of Germany 0.6 1.4 0.5 1.2 1.0 0.4 0.8 0.3 0.6 0.2 0.4 0.1 0.2 0.0 0.0 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 Minimum Distance of Observed Volatilities from Taylor Curve of Italy Minimum Distance of Observed Volatilities from Taylor Curve of Japan 1.25 2.5 1.00 2.0 0.75 1.5 0.50 1.0 0.25 0.5 0.00 0.0 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 Minimum Distance of Observed Volatilities from Taylor Curve of UK 0.6 0.5 0.4 0.3 0.2 0.1 0.0 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 Figure 4.2 Monetary policy effectiveness over time 18 In all countries, the effectiveness of monetary policy drastically decreased during global crisis period in 2008 Although during the period after 2012, the distance to the efficient frontier was maintained at stable level, the role of monetary policy in stabilizing output and price still much weakened in comparison with the period before the crisis in most of the study countries The monetary policy effectiveness also changed in accordance with management practice in the countries with the reduction in periods impacted by international and domestic shocks 4.3.3 Shifts in the Taylor curve 4.4 Conclusion CHAPTER – DEVELOPMENT IMPACTS ON OF FINANCIAL MONETARY POLICY EFFECTIVENESS 5.1 Introduction In this chapter of the thesis, I assess impacts of the financial development on the effectiveness of monetary policy in G-7 countries On the basis of the monetary policy effectiveness’s measurement implemented in chapter 4, I apply the measure to the degree of financial development established by Svirydzenka (2016) based on Sahay et al (2015), then, regression analysis is conducted to test the relationship between the degree of financial development and monetary policy effectiveness in addition to some macroeconomic variables added to the model 5.2 Methodology 5.2.1 Stationarity test 5.2.2 Cointegration test 5.2.3 Study model 19 The study model is developed on the background of some previous studies including Carranza, Galdon-sanchez & Gomezbiscarri (2010); Ma & Lin (2016), as follows: 𝑀𝑃𝐸𝑖𝑡 = 𝛼𝐹𝐷𝑖𝑡 + 𝜷′ 𝒛𝒊𝒕 + 𝛾𝐶𝑅𝐼𝑆𝐼𝑆𝑖𝑡 + 𝜃𝐼𝑇𝑖𝑡 + 𝜀𝑖𝑡 𝑀𝑃𝐸𝑖𝑡 = 𝛼1 𝐹𝐼𝑖𝑡 + 𝛼2 𝐹𝑀𝑖𝑡 + 𝜷′𝟏 𝒛𝒊𝒕 (5.1) + 𝛾1 𝐶𝑅𝐼𝑆𝐼𝑆𝑖𝑡 + 𝜃1 𝐼𝑇𝑖𝑡 + 𝜀𝑖𝑡 (5.2) 𝑀𝑃𝐸𝑖𝑡 = 𝛼11 𝐹𝐼𝐴𝑖𝑡 + 𝛼12 𝐹𝐼𝐷𝑖𝑡 + 𝛼13 𝐹𝐼𝐸𝑖𝑡 + 𝛼21 𝐹𝑀𝐴𝑖𝑡 + 𝛼22 𝐹𝑀𝐷𝑖𝑡 + 𝛼23 𝐹𝑀𝐸𝑖𝑡 + 𝜷′𝟐 𝒛𝒊𝒕 + 𝛾2 𝐶𝑅𝐼𝑆𝐼𝑆𝑖𝑡 + 𝜃2 𝐼𝑇𝑖𝑡 + 𝜀𝑖𝑡 Where 𝑀𝑃𝐸𝑖𝑡 represents the monetary policy effectiveness of country 𝑖 in year 𝑡 It is remarkable that the higher MPE is, the less effective monetary policy is and vice versa 𝐹𝐷𝑖𝑡 measures the level of financial development of country 𝑖 in year 𝑡 In order to examine impacts of component indicators of financial development including financial market index (FM) and financial institutions index (FI), I estimate the model (5.2) with independent variables of major concern which are 𝐹𝑀𝑖𝑡 and 𝐹𝐼𝑖𝑡 Similarly, I repeat the estimation and replaces independent variables which are the specific component financial development indicators in the model (5.3) 𝒛𝒊𝒕 is a vector of control variables, 𝐶𝑅𝐼𝑆𝐼𝑆𝑖𝑡 is the crisis dummy, 𝐼𝑇𝑖𝑡 is the inflation targeting dummy variable and 𝜀𝑖𝑡 are errors of the model with mean equal to and following i.i.d distribution I use different tests so as to select the best estimate method with study data including F-test, Breusch-Pagan Lagrangian test and Hausman test After performing tests before regression and selecting estimate method, I estimate the model by the method of Pooled OLS with respect to the model (5.1) and (5.2) and the FEM method with respect to the model (5.3) Defect tests after regression are also applied and in the case the model contains defects, I fix the defects of the model with GLS (5.3) 20 5.2.4 Data I use panel data of countries in the period between 1980 and 2016, depending on the data availability The data are mainly collected from sources disclosed by World Bank, IMF and calculated by the author in Chapter 5.3 Results and Discussion 5.3.1 Stationarity test The results report that except MPE and FIE which integrate at level (1), the other variables integrates at level (0) 5.3.2 Cointegration test Testing cointegration on the data table comes to the results that there is no long term relationship between variables 5.3.3 Analyzing correlation matrix and testing multicollinearity The study results indicate that there is not serious multicollinearity phenomenon in the study model 5.3.4 Endogeneity test The test results cannot reject that the estimate model does not contain endogeneity 5.3.5 Autocorrelation test The results of autocorrelation test of Wooldridge set indicate that, with H0 assumption, the regression model involving no autocorrelation at level cannot be rejected in all models 5.3.6 Heteroskedasticity test The results of heteroskedasticity test with Breusch-Pagan test and Modified Wald test show that in all three models of concern, the H0 assumption suggests that the model with homoscedasticity is rejected at significant level of 1% 21 5.3.7 Impacts of financial development on monetary policy effectiveness FGLS regression results indicate that financial development puts negative impacts on monetary policy effectiveness with statistically significant level of 1% When examining the impact of the component financial development index by estimating the model (5.2) and (5.3) with the gradual addition technique of control variables, the results show that the development level of financial institutions (FI) positively impacts, while developing the financial market (FM) puts a strong negative impact on monetary policy effectiveness In particular, the impact of FI is mainly caused by the impact of the FID index and the impact of FM is mainly caused by the impact of the FME index, with statistical significance found at 10% for those indices in the model (5.3) These results imply that the deeper financial institutions are, or the greater the development of banking and financial intermediaries is, the more monetary policy will increase the impact on the economy In contrast, the more effective the financial market is, the easier it is for actors to defend against the monetary policy shocks, thus reducing the effectiveness of policy impacts The findings of this study are consistent with the reports of previous studies (see more, Cecchetti, 1999; Lastrapes & McMillin, 2004; McCauley, 2008; Carranza, Galdon-sanchez & Gomez-biscarri, 2010; Ma & Lin, 2016) 5.4 Conclusion CHAPTER – CONCLUSION AND POLICY IMPLICATION 6.1 Conclusion 22 Table 5.10 Impacting regressive results of financial development on monetary policy effectiveness Model (5.1) FD GFCF IT CRISIS FI FM FIA FID FIE FMA FMD FME cons Wald test (1) 0.009*** (2) 0.009*** -0.002*** Model (5.2) (3) 0.003 -0.001*** 0.001 0.014*** (4) -0.001 0.006*** Model (5.3) (5) (6) -0.002*** -0.001*** 0.001 0.014*** -0.009* 0.005** -0.004 0.007*** (7) -0.004*** -0.004** -0.002 -0.001 0.001 0.005 0.003 -0.007 -0.037 0.002 0.002 0.004* -0.001 14.02*** 77.80*** 158.61*** 15.09*** 80.46*** 163.34*** 22.72*** (8) (9) -0.002*** -0.001*** 0.001 0.015*** 0.001 -0.009* -0.042 0.002 0.003 0.004* 0.002 -0.003 -0.009* -0.036 0.002 0.001 0.004* 0.004 87.20*** 170.77*** Note: (t_statistic) in brackets () *, **, *** represents significance of 10%, 5%, 1%, respectively 23 In this thesis, with the objective of assessing the role of development in the financial system towards the effectiveness of monetary policy, I overcome some limitations of previous studies, and consider the overall and partial impact the aspects of the financial development to the effectiveness of monetary policy in the context of using the monetary policy effectiveness measure based on the Taylor curve theory The study was conducted on the sample of G-7 developed countries in the period between 1951 and 2017 The results from the study show that: (1) there is a trade-off relationship in the variance of output and inflation, supporting the Taylor curve theory in the studied countries (2) The efficient frontier of monetary policy reasonably built based on the Taylor curve theory is the difference between countries, and there is a shift over time (3) The effectiveness of monetary policy changes over time, monetary policy tends to be ineffective in the crisis period and under the impacts of domestic and international shocks, in contrast, the ability to affect the economy to achieve central bank's objectives in implementing monetary policy increases in the recovery periods, in line with actual happenings (4) Financial development negatively affects the effectiveness of monetary policy In particular, the development of the financial market (increasing the efficiency of the market reflected by the development of the capital market, the increase of non-bank financial intermediaries, a variety of financial instruments and products and payment technology, which implies the development of a market-based financial system) reduce the effectiveness of monetary policy In contrast, the development of financial institutions (enhancing the depth and 24 scale of financial institutions, implying bank-based financial system) is a factor contributing to improve the effectiveness of monetary policy (5) There has not yet been statistical evidence of the impact of the inflation targeting regime in operating monetary policy on improving the effectiveness of monetary policy in the research period (6) Disorders and crises in the economy minimize the role of monetary policy in regulating the economy 6.2 Policy implications Firstly, policy making agencies in countries can consider the measurement of the monetary policy effectiveness based on solving the optimal control problem, according to the Taylor curve theory Secondly, countries require policies so as to enhance the depth, size and variety of financial institutions This enables to enhance healthy competition in the financial market and also create a full and efficient transmission environment for monetary policy Thirdly, central banks need to monitor the development of the national financial system to make adjustments in making monetary policy In particular, it is necessary to anticipate difficulties in monetary policy planning on a market-based financial system, thus, central banks should consider using other support policies or alternative tools flexibly for goals achievement In order to ease the pressure on monetary policy in regulating macro-economy, policy-making agencies need policy solutions to promote the financial market to develop in a healthy way so that they can utilize advantages of financial market towards economic growth and simultaneously limiting 25 uncertainties in the financial market, causing spillover effects on macroeconomic instability and weakening the effectiveness of monetary policy Fourthly, especially for developing countries, under circumstance of weak technical infrastructure, incomplete legal institutions, central bank of little independence, it is required to carefully consider between benefits and risks before applying the inflation targeting regime in operating monetary policy Finally, future studies can develop micro-models that focus on monetary transmission channels in a theoretical model including the level of financial development which can provide a firmer direction for next steps in empirical studies LIST OF AUTHOR’S PUBLICATION Thesis title: FINANCIAL DEVELOPMENT AND THE EFFECTIVENESS OF MONETARY POLICY Major: Finance- Banking Code: 9340201 PhD Student: Ho Thi Lam Supervisor: Tran Ngoc Tho The inflation–output stability trade-off and monetary policy Macroeconomic Effectiveness Performance and Monetary Policy