Open Economies Review

, Volume 19, Issue 3, pp 305–336 | Cite as

Monetary Policy in Illiquid Markets: Options for a Small Open Economy

  • Edda Claus
  • Mardi Dungey
  • Renée Fry
Research Article


Two impediments to effective monetary policy operation include illiquidity in bond markets and the zero bound of interest rates. Under these conditions alternative means of enacting monetary policy may be required. This paper empirically explores policy options implemented through equity and currency markets that will generate similar inflation responses at different time horizons. In terms of GDP loss the least costly means of achieving a particular long run inflation outcome is via the current monetary policy arrangements. Currency market alternatives are volatile but less expensive than the equity market in terms of output loss for short term inflation horizons.


Monetary policy alternatives Illiquid markets Liquidity trap Zero bound interest rates Latent factors Structural VAR 

JEL Classification

E52 C51 



We would like to thank an anonymous referee and the editor of this journal for useful feedback.


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Copyright information

© Springer Science+Business Media, LLC 2007

Authors and Affiliations

  1. 1.Institute for International Integration StudiesTrinity College DublinDublinIreland
  2. 2.Centre for Applied Macroeconomic AnalysisThe Australian National UniversityCanberraAustralia
  3. 3.Centre for Financial Analysis and PolicyUniversity of CambridgeCambridgeUK

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