A macroeconometric model with oligopolistic banks: Monetary control, inflation and growth in Israel

We develop a macroeconomic model, in which the roles of credit as well as money markets are clearly articulated, and both the demand and the supply of money are expressed. A distinctive feature of the model is that the banking system is assumed to be oligopolistic. It is shown that as the banking system becomes more competitive, inflation becomes less repressed and interest rate policy more effective. Empirical estimates of the model are derived using data for Israel. Simulations of the model show that interest rate policy has a powerful effect on inflation, which varies directly with competition in the banking sector and the degree of financial intermediation. It is shown that if the central bank fixes its nominal interest rate for too long, this induces nominal instability. However, the time lag is sufficiently long to permit appropriate adjustments to monetary policy.