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Subsidizing prospective deficits: Public spending volatility and the central bank’s interest rate policy

August 9, 2013

This working paper examines central banks’ interest rate policy behaviors in OECD
countries. I argue that central banks’ interest rate policy behaviors may be
distorted toward profit-maximizing-an objective that runs counter to the central
bank’s commitment to price stability-when central banks are obliged to submit a
target level of their operating profits to their governments in response to the
latter’s higher budgetary financing needs. I further argue that this phenomenon is
more observable in highly unequal countries and when their domestic
currencies are depreciating at a faster rate. I then test this argument with threshold regression models using income inequality and quarterly exchange rate volatility as thresholds, the results lend initial support to the theoretical argument.

From → Working papers

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