Does development finance pose an additional risk to monetary policy?

Abstract

This study investigates whether remittances entail extra risk for macroeconomic policy management and examines the role (if any) that the financial system can play in the interaction between remittances and monetary policy. Employing panel data for 106 developing countries from 1970 to 2013, the results from our panel vector autoregressive (PVAR) model reveal that remittance volatility reduces macroeconomic risk in developing countries while simultaneously stimulating a reduction in domestic interest rates. This finding remains robust to alternative specifications of remittance volatility and monetary policy risk and to variations in the degree of financial development. The key lesson from this study is that developing countries can leverage the positive impact of remittances in reducing macroeconomic instability by implementing policies that induce remittances.