Academic journal article Journal of Economic and Social Studies

Channels of Monetary Transmission in the CIS: A Review1

Academic journal article Journal of Economic and Social Studies

Channels of Monetary Transmission in the CIS: A Review1

Article excerpt

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The Channels of Monetary Transmission: an Overview

The proposition that policy interventions can affect macroeconomic behavior has become a leading line of thought among both researchers and practitioners. It is said that policy-makers are able to influence the flow of events in the real economy by targeting specific economic aggregates of interest. They achieve this by calibrating certain policy variables - those over which they have direct power and control. An intervention into the policy variable then, in theory, transmits its innovation into the real economy via a certain channel. While policy interventions and end-of-the- day effects on the real economy are largely known and measurable, the dynamic that occurs in the transmission channel is quite challenging to assess and to measure. The channels of monetary transmission are often called a "black box", suggesting that we know that monetary policy does influence real economic aggregates, but we don't always know how exactly (Bernanke and Gertler, 1995).

Policy makers typically have two major tools for economic control at their disposal: fiscal and monetary policy. Fiscal policy has never been consistenly viewed as a reliable variable for macroeconomic stabilization (Mishra, Montiel, and Spilimbergo, 2010). The fiscal channel often operates slowly, inefficiently, and usually aggrevates situations by acting as a pro-cyclical catalyst of any exogenous shock. It's not to say that the fiscal arm is completely useless, but fiscal policy must be almost universally accompanied by a credible and congruent stance from the national central bank. In short, much due to the imperfections associated with the fiscal dimension of policy making, monetary policy often takes on the lead role in economic stabilization and control.

It has become conventional to believe that monetary policy indeed affects lives of economic agents, although sometimes in an undirect way (Mishkin, 1996). The transmission channels through which monetary policy is conducted are often subtle and complex. While the aim has always been to target a real variable such as aggregate output or employment, the selection of the correct channel of monetary transmission in order to execute the desired plan is often impeded by the structural issues of a given economy's internal context. The story of the channels of monetary transmission, although without doubt built upon certain fundamental theoretical blocs, is an empirical issue. The workings of each monetary transmission channel (and there are several of them) depend on a plethora of factors, ranging from the overall stage of macroeconomic development to the nuances of micro-structures of domestic financial markets (Checetti, 1999). Those factors differ tremendously in different regions and regimes of the world, thus necessisating differentiated and/or regional approaches to the study of monetary transmission channels.

Description of the Channels of Monetary Transmission

There are at least seven channels of monetary transmission that we can distinguish: interest rate channel, exchange rate channel, bank lending channel, balance sheet channel, asset price channel, monetary channel, and expectation channel. Empirically, it has been proven that the interest rate channel is the most dominant one for the case of developed economies with high-quality financial markets. In general, the interest channel is built on a Keynesian view that monetary policy can affect real costs of borrowing by changing nominal interest rates. Because prices are sticky and require time to adjust, nominal interest rate differentials transform into a corresponding adjustment in the real interest rate, which in turn affects spending and investment decisions in the economy.

Contrary to the interest rate channel, the exchange rate channel is usually viewed as the most important monetary transmission channel in developing countries (Coricelli, Egert, and MacDonald, 2005). …

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