Monetary Policy and Financial Stability : A CEMAC Zone Case Study

This article scrutinizes the relation between the monetary policy and the financial stability driving data from CEMAC zone countries. Furthermore, it aims to know if in addition to its mandate about price stability, the BEAC bank integrates the financial stability in its monetary policy. My method is based on the Taylor Increased Rule estimation of the financial price assets and the econometric test. The results show that the separated policy-mix better fits for CEMAC zone countries. Furthermore, it comes out that the adapted monetary policy practiced by BEAC bank currently ensures the price stability.


Introduction
This paper aims to answer the question whether the financial stability is correlated to the price stability.The financial crisis in 2007 in USA had demonstrated that the financial instability was not the main phenomenon that solely affect emerging economies likely to face economic policy errors or speculative attacks of foreign investors (Cartapanis, 2011).This crisis that the USA financial system, which is viewed as the most reliable, encountered demonstrated that the complex factors leading to a financial instability.It has contributed to the profound revision of most existing financial and bank governance systems with a particular attention to the role of central banks and the relation between monetary and financial stability.In fact, the insight from this financial crisis insistently raises the issue whether, based on the current context of economic globalization, it is not possible to add the financial stability as another objective to the monetary stability within the core responsibility of central banks.
In contrast to monetary stability, which is easily definable and quantifiable, financial stability is a complex concept, hard to grasp and has not yet got a granted definition (Gill Hammond, 2007).It depends on microprudential policy which is concerned on the one hand by the microprudential, which deals with the prevention of individual bank difficulties and on the other hand macroeconomic and monetary stability objectives.
The financial stability can also be accounted by in terms of the financial system instability absence in a whole (Note 1).It is not synonymous to the elimination of the market volatility, but rather by the premonition against an excessive volatility of the asset price on the one hand, and against an excessive expansion of the credit on the other hand.
The financial stability can also become an important factor for the economic growth; the relation between the monetary policy and the financial stability remains a priority either for theoretical or applied research along these decades.
Firstly, on the theoretical ground, the debate on the monetary policy is focused on the relation between inflation and economic activity.The question related to financial stability or instability has been given the second position.In fact, till the crisis, the consensus guiding central bank actions since 1990 was based on the hypothesis that monetary stability was a relevant and sufficient condition for financial stability.Otherwise, the monetary stability necessarily conducted to the financial stability and sustainable economic growth.start of the crisis in 2007 has shown that the monetary stability from 1990 to 2000 was prejudicial to financial stability since it has incited economic actors, and particularly banks, to take more risks which lead to the crisis (Borio et al., 2012): it is the credibility paradox.It follows that the mere relation which consisted in claiming that monetary stability is a relevant and sufficient condition to financial stability does not hold.The inflation is not a good indicator to predict a financial crisis (Note 2) and the financial stability becomes a relevant condition to economic growth (Note 3).In this connection, the macroprudential tool looks like an instrument dedicated to fight financial instability, hence the relation between the financial stability and monetary stability gets its climax position either in theoretical or applied research.
Two approaches current raise the debate on the orientation policy clean vs lean monetary policy in front of macroprudential policy: separated policy mix and integrated policy mixed.
The former advocates the separation between monetary policy and macro-prudential policy, each being under the supervision of specific and distinct bodies, one of which is in charge of monetary stability and the other in charge of financial stability (Svensson, 2012, Bernanke, 2010, 2012).According to Tinbergen"s rule and Mundell Principle, the separated policy mix asserts that monetary policy depends totally on monetary stability and macroprudential policy on financial stability.The central bank is more implied in the supervision of financial establishments.
The latter approach postulates an integration of the monetary policy and macroprudential policy.One or the other should be ruled by the same body for a better organization between respective objectives (Adrian & Shin, 2009;Mishkin, 2011;Eichengreen et al., 2011).The monetary and financial stability will be integrated in the same Augmented Taylor Rule.It is about the extension of Taylor Rule in order to include a financial variable such as the credit (Christiano et al, 2010), monetary supply (Issing, 2011) or financial imperfection indicators (Wooford & Curdia, 2009) (Note 4).However, this approach shows some limitations in connection to the implementation of the rule elaborated by Tinbergen in 1952.Thus, the interest rate cannot alone achieve three objectives: monetary stability, macroconjectural stability, and financial stability.
Intermediary solutions between the two approaches are possible (Note 5).In the light of Beau et al. (2011), the optimal policy mix solely depends on the type of shock, the crossing conditions regarding inflation and financial stability.So, for some central bankers, the integrated system represents an emergency solution, but should only be used if it is "the only possible solution" in case of extreme crisis.Under these exceptional conditions, Bernanke (2012) does not exclude to resort to the interest rate to fight financial instability.Yet, uncoupled policy mix suits under normal circumstances.The choice of policy mix is not simply a theoretical issue, it is rather empirical because it varies according to macroeconomic conditions.
In fact, under empirical view, the general dynamic equilibrium models and stochastic are the main macro conjectural modeling tools issued from macroeconomic theory since the beginning of 2000s.They start integrating financial frictions that they ever integrated before the crisis.The most current integrate the action of macroprudential policy in addition to that of monetary policy.
A number of authors even go further in combining one or more macroprudential tools with one Augmented Taylor Rule for a given financial target, and hence permitting the articulation of the interest rate and the macroprudential tools to restore financial stability.
Moreover, under methodological perspective, the diversity of model is important.Some models standardize reply coefficients of Taylor Rule when the others optimize them.Even when the reply coefficients of Taylor Rule result from optimization, methods are different.The optimization can concern inflation change and production.Or one can have recourse to one function of ad hoc loss of the central bank with or without financial stability as a support argument.
It is thus difficult based on the results of the previous conclusions to hypothesize whether the central banks should take or should not take into account macroprudential policy for their rate regulation.As things stand, it is obvious that a policy that enables to face the accumulation of financial disequilibria is not appropriate and it is not enough that monetary policy responsible try to eradicate macroeconomic consequences during bear phase.
The question that immediately crops out is to know if in the future the monetary policy will more contribute to maintain the financial stability and eventually gets an important role.So, this is the proven interest of carrying out a study dealing with the relation between monetary policy and financial stability.Furthermore, if we take for granted the hypothesis which is widespread in the literature that macroprudential policy is an essential condition for financial stability, it is worth examining how such a concern is observed in CEMAC (Note 6) zone in view of the importance of the direct and indirect channels through which the asset prices affect the economic agent behaviours and the whole economy.
In fact, in CEMAC zone countries, a distinct bank commission shares the bank regulation with BEAC bank, but the global prudential responsibility depends on CEMAC zone council of Ministers.However, other regional entities are in charge of the regulation of non-bank financial establishments of the zone.
Since the macroprudential responsibility is shared, the question raises is whether in addition to its role for financial stability, BEAC bank integrates financial stability in its governance of monetary stability.
The remaining work includes two sections and a concluding remark.Second 2 is about the determination of the model of reaction function of the central bank; the estimation and the analysis of the key results is the concern of section 3.

Determination Model for BEAC Reaction Function
This section is devoted to provide an overview of the theoretical framework worthy for the analysis before providing specificity of the model for estimation purpose.

Presentation of the Model
Starting from the hypothesis that the macroprudential policy should stand as an essential tool in the future for the financial stability in CEMAC zone, we purport to provide a method capable of modelling a reaction function for monetary authorities that can include one or more types of macroprudential policies.
Considering, under this perspective Angeloni and Faia (2013), Kannan et al. (2012) and IMF (2012, 2013), a general dynamic equilibrium model and stochastic, which is, as stated so far, the main tool of macroprudential modelling issued from macroeconomic theory.
The advantage of this model is that it enables to incorporate macroprudential rules used to limit financial fluctuations and to represent monetary policy by means of a Taylor Rule which can make reply the interest rate either to fluctuation gaps, production gap and financial gap.
This model is also advantageous as it represents several types of mix policies: separated mix policy according to which monetary policy does not correspond to financial conditions and it centers on the stability of inflation and production, and integrated policy mix which admits that monetary policy cooperate with macroprudential policy and backs it up to respond to financial instability.
The response coefficient value to financial condition under the Taylor Rule that this model uses seems to be the variable that better represents the point of articulation between monetary policy and macroprudential policy in the search for financial stability.
It is then fortunate to explain the differences of the coefficient value and policy mix nature indeed.The function of reaction looks like an Augmented Taylor Rule whose loss function is given the following schema: Where in: -E t , the expectancy at time t of the loss; y t , refers to effective growth rate at time t (y* is the potential production rate); πt, stands for the inflation rate at time t (is the token target value by the central banker); pt, is the financial stability level at time t and p* its optimal level; µt, the different type of shocks that affect an economic activity.
The equation (1) formalizes the response of the nominal interest rate of the central bank with three gaps: an inflation gap, a production gap and a financial gap.

Specification of the Model
It is worth claiming that a financial gap is very complex as it can refer to credit spread, the price of real estate, the price of actions, credit growth rate, or money supply (we can also find synthetic financial indicators).
The inflation, production and financial gap response coefficients are β, γ, δ respectively.These coefficients show the intensity of the central bank response and are on top of economy structure (for example inflation/production arbitration) and the central bank preferences represented in its loss function.In this perspective, more the response to the interest rate to financial condition is higher, more the policy mix becomes integrated; conversely when the response is low so the policy mix is separated.The monetary rule specific to this type is as follows: Where in: -i t is the central interest rate dictated by monetary authorities at time t; -X t refers to output gap or production gap at time t; -(π t -π*) refers to a gap at time t between the inflation rate and the target established by monetary authorities; -(  −  * )  represents a gap at time t between financial value (pt) and their value being fundamental (p*); µ  represents error term.
This specification is advantageous as mentioned above because it permits to: 1/-draw a conclusion from policy mix modalities between monetary policy and macroprudential policy; 2/-distinguish between two cases of polarity: a separated policy mix wherein monetary policy remains concentrated on the financial stability and macro-conjectural policy whereas macro prudential policy aims to financial stability in adjusting the central rate concerning financial conditions.
Moreover, we put forward the hypothesis that BEAC is incapable of distinguishing movements in accordance with fundamentals to those which are not.
Following Wooford (2012), one can admit that there is arbitration of BEAC monetary authorities between macroeconomic stability (inflation, production) and financial stability.The response coefficients will depend on BEAC preferences in its loss function.For IFM (2013), it is a commonly argued that for a central bank to think of financial stability affects its anti-inflationist credibility.Three types of constraints are distinguished indeed: 1-γ must be negative, we expect a negative relation between γ and δ, hence a separate policy-mix due to the objective conflict prejudicial to the central bank credibility in relation to the price stability.Formally, we expect a negative sign for the explanatory variable γ.
2-The expected sign for β variable, i.e. the production, is less obvious.Due to the objective conflict, we can expect a negative sign.Yet, if the central bank is more "Dove" (high preference for the production and employment and the financial stability by extension) than "falcon" (strong anti-inflationist preference), he will likely care about the production and look more open to other objectives than inflation.In this perspective, he can also be open to financial objective as a final objective.The expected sign in front of β is ambiguous.
3-The financial gap response coefficient value (δ) is representative to the articulation between monetary policy and macroprudential policy.If the coefficient value is significant, the monetary policy cares about the financial stability.The policy-mix is thus integrated.However, if the coefficient value is not significant, BEAC bank cares less about the financial stability.In this respect, the macroprudential policy is affected by the financial stability objective.The ensuing section is devoted to the estimation of the model as well as its analysis.

Estimation of the Model and Analysis of the Main Results
We are firstly going to estimate the model through equation 2 before undertaking the analysis of the main major results.

The Model Estimation
The model estimation requires a prior choice of the different variables of the model.This mainly concerns the choice of the interest rate measure, inflation rate, and financial and production gap.In fact, this study drives data from BEAC database.These are annual database and cover 1980-2013 (Note 7) period.

a) The analysis of the model variable
Firstly, the interest rate is nothing but the central bank refinancing rate for an annual change period.Figure 1 below illustrates the evolution of this variable through time.Secondly, the inflation rate is the consumer price index growth rate (IPC) during a year provided by BEAC.
Figure 2 shows this variable.Thirdly, the output gap measure, the effective rate marked y t represents a growth computed from volume index of a real GDP taken from BEAC statistics.We have specifically used In (GDP t /GDP*) whereof GDP* is a potential GDP.Potential GDP data have been elaborated following Hodrick-Prescott filter application (Note 8).This approach is worth considering because it provides a statistic estimation framework compatible with a central bank real time analysis.Chart 3 hereafter provide a synthetic overview of this variable for 1980-2013 period.Finally, to get macroprudential value, we hypothesize that in CEMAC zone, financial assets are essentially made of cash.Money is a financial asset whose holding depends on its price in connection to other assets.A rise of the interest rate can lead agents to orientate their cash towards a non-monetary investment which is more profitable.
Based on thee bank system and the underdevelopment of money markets, we have selected "proxy" as our value for financial stability, money supply (M2).Statistic data taken as fundamental for this financial variable have been formulated based on Hodrick-Prescott filter.It can be determined as an evaluation error on the financial market index in relation to theoretical price, that is to say, according to the difference between its effective value and potential value established in percentage of the potential value or by logarithmic version In (pt/p*) used afterward.We have firstly proceeded by Dickey-Fuller Augmented test (ADF) in order to test the existence of a unit root, that is, the average of non-stationary tested variables and determine their hierarchy in analysis.Owing to the intermingled link between the interest rate and macroeconomic variables taken as explanatory variables, we could possibly be in front of reverse causality, and hence endogeneity bias.In order to scrutinize this potential problem, we make use of Granger causality test, the results of which are formulated in Table 2 below.
Table 2. Granger test results

Tested hypotheses F-statistics (p-value) Conclusion
Interest rate does not determine output-gap 0,07 (0,93) Acceptation Interest rate does not determine inflation 0,34 (0,72) Acceptation Interest rate does not determine money supply 0,39 (0,68) Acceptation The results issued from Granger Test come to the conclusion that the three hypotheses are well accepted.Indeed, there is probably no reverse causality in the model, and hence no endogeneity bias.The upcoming section highlights the major results of the estimation.

Major Results of the Estimation
Based on Eviews 7 software, the results of estimation (cf.annexes) appear as follows (Note 9): Under econometric diagnostic level, results are robust to heteroskedasticity by White method application.%Q indicator proves that there is no fraction auto-correlation, and thence to no delay.Finally, Jarque-Bera test confirms a normal fraction.
Generally speaking, the processed tests on the model promote the validation of the model to represent the interest rate dynamics.In broad sense, two hypotheses can be formulated: 1) Separated policy mix practice in CEMAC zone; 2) An adapted monetary policy rule practice.

Separated Policy Mix Practice
It appears that the coefficient associated to asset price variability is low, that is, non-significant.This means that the selected macroprudential tool (money supply) directly constrains borrowers and further reduces the response of monetary policy to financial stability.It is thus less in favour of integrated policy mix wherein monetary policy responds to financial instability in order to support macroprudential policy for financial stability.
It follows that financial stability is not an intermediary objective to BEAC as Figure 5 below illustrated.
(---: macroprudential variable, __: interest rate) Figure 5.The evolution of the central rate and financial asset prices It results from Figure 5 that BEAC does not take into account financial asset price because the two series (interest rate and asset price) are not procyclical.This clearly demonstrates that monetary authorities of CEMAC zone are less likely to change their strategy to incorporate a new financial stability objective.Thus, it is doubtless that they will prefer to keep their traditional consensus of separated policy mix instead of integrated policy mix.This confirms the principle that the central rate is independent of the evolution of financial asset price.Since the symbol γ is negative, taking into account a new financial stability objective leads to a conflict of objectives which is prejudicial to the credibility of BEAC bank in terms of price stability.As BEAC grants great interest on inflation and engages its credibility in order to achieve its price stability, more it is reluctant to pay attention to financial stability.In this respect, the financial stability must be under macroprudential policy.This leads to the adoption of the separated policy mix in CEMAC zone.
The Implementation of the separate policy mix requires the BEAC bank to adopt an efficient supervision system.This will imply BEAC bank to extend its supervision on banks as well as other intermediary financial establishments, i.e. non-bank financial establishments.

An Adapted Monetary Policy Rule Practice
Like the standard Taylor Rule, the monetary policy is optimal if it minimizes the inflation and production gaps.
As the coefficient γ is negative, this presupposes that the inflation target in CEMAC zone is above the current inflation.In this respect, the BEAC bank authorities are obliged to maintain the short term base rate interest at a low level in order to bring the current inflation up to its target level.
Moreover, the non-significant output gap response coefficient does not seem to influence policy mix in CEMAC zone.Under these conditions, BEAC bank is more concerned with inflation and is not open to other objectives.Economic test results advocate an adapted monetary policy rule with a unique objective related to goods and service price stability.Put otherwise, as the interest rate is the adjustment variable which allows to stabilize inflation to its low level in the CEMAC zone leads to the implementation of an adapted monetary policy.
By maintaining interest rate to its low level, monetary policy can stimulate demand, but under the current circumstances in CEMAC zone, the efficiency of the decrease of credit rate for consumption stimulation and private investments solely depends on the good working of the channel for bank credit.Marginal advantages of supplementary stimulus are larger when banks are ready to increase credit availability in adjusting credit allocation in accordance with monetary condition loosening when credit procedures are not loosened.
Yet, it is obvious that institutional organizations in CEMAC zone are more and more facing prudential norms which do not prompt them to allocate credits (Engone, 2014).

Conclusion
This paper has examined the link between the monetary policy and financial stability in CEMAC zone.It has checked if the financial stability management in the CEMAC zone is integrated in the monetary policy governance.In this connection, a BEAC bank reaction function is estimated in integrating not only an inflation

Conclusion:
Hypothesis A in every table: we reject tested hypothesis for X, we accept that of INF and accept bound to P. This provides an indication for the final estimation: we can expect X to be significant, P is slightly significant or slightly non-significant, and INF is non-significant.
Hypothesis B in every table: we accept the tested hypothesis for all cases.This presupposes that there is no reverse causality for none variables.There is no endogeneity to deal with.

Estimations:
1) No correction with White

Figure 1 .
Figure 1.The evolution of interest rate from 1980 to 2013 (%)

Table 1 .
Dickey-Fuller Augment test resultsIt transpires from the test that the estimated values of Dickey-Fuller Augmented (ADF) statistics are generally low to the critical values at significance level 1%.Consequently, we reject the null unit root hypothesis in favour of alternative variable stationarity hypothesis.It comes out that all variables are stationary.It is thus pointless to characterize one or more cointegration relation.Let"s look at identification strategy in the upcoming lines.
Table 1 below points out the major results.