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Role of Bangladesh Monetary Policy

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The Role of Aggregate Demand and Supply Shocks in a Low-Income Country: Evidence from Bangladesh
Omar H.M.N. Bashar
The Journal of Developing Areas, Volume 44, Number 2, Spring 2011, pp. 243-264 (Article)
Published by Tennessee State University College of Business DOI: 10.1353/jda.0.0095

For additional information about this article http://muse.jhu.edu/journals/jda/summary/v044/44.2.bashar.html Access Provided by Bangladesh University of Professionals at 05/29/11 5:42AM GMT

THE ROLE OF AGGREGATE DEMAND AND SUPPLY SHOCKS IN A LOW-INCOME COUNTRY: EVIDENCE FROM BANGLADESH
Omar H.M.N. Bashar Deakin University, Australia

ABSTRACT
This paper explores the relative role of aggregate demand and supply shocks in affecting the output level and inflation rate in a low-income country vulnerable to various economic shocks. The study uses Bangladesh data, and following Cover et al (2006), employs a modification of the BlanchardQuah (BQ) approach, in which the two shocks are allowed to be correlated. Strong evidence is found for the hypothesis that aggregate demand and supply shocks are interrelated in Bangladesh. For the case in which causality is assumed to be running from demand to supply shocks, it was found that an independent supply shock plays significant role for fluctuations in inflation, which was absent in the standard BQ model. The results suggest that a tightening of monetary policy may lead to an adverse effect on the long-run growth potential and some supply-side policies may be required to supplement contractionary monetary policy in combating inflation in Bangladesh. JEL Classifications: E3, O11, C32 Keywords: Aggregate Demand and Supply Shocks, Blanchard-Quah Decompositions, Monetary Policy, Bangladesh. Corresponding Author’s Email Address: omar.bashar@deakin.edu.au

INTRODUCTION Analyzing the role of aggregate demand and supply shocks in an...

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