Wage-Price Flexibility, Exchange Rate Flexibility, Capital Controls, and the Adjustment Speed in the Money Market

The speed with which macro variables in the money market adjust toward their long-run equilibrium values has great implication for the effectiveness of monetary policy. Previous research shows that the adjustment speed is higher in more open economies. In this paper, we introduce three additional determinants of adjustment speed. More precisely, we argue that more wage-price flexibility, more exchange rate flexibility, and less restriction on capital flows foster the speed of adjustment. Empirically, a cross-sectional model is specified in which adjustment speed is treated as the dependent variable and a measure of openness, a measure of wage-price flexibility, a measure of exchange rate flexibility, and black market premium as a measure of capital controls are treated as independent variables. After estimating the adjustment speed using the bounds testing approach to cointegration and error-correction modeling for 28 developing countries and after constructing the other four independent variables for the same countries, we estimate different variants of the cross-sectional model.