How Effective is Monetary Transmission in Low-Income Countries? A Survey of the Empirical Evidence

IMF Working Papers, June 1, 2012

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The paper surveys the evidence on the effectiveness of monetary transmission in low-income countries.
The review finds it "hard to come away ... with much confidence in the strength of monetary transmission in such countries."
The authors distinguish between two interpretations of the absence of evidence for strong monetary transmission:
- "facts on the ground" interpretation
- "methodological deficiencies" interpretation
The authors state: "We suspect that 'facts on the ground' are an important part of the story."
If the conjecture that facts on the ground drive weak transmission is correct, then "the stabilization challenge in developing countries is acute indeed."

Two competing explanations are highlighted:
- Empirical absence of strong monetary transmission may reflect real structural features and market frictions in low-income countries ("facts on the ground").
- Alternative explanation is that empirical methods used to date suffer from deficiencies, leading to underestimation of transmission ("methodological deficiencies").
The authors lean toward the view that structural realities ("facts on the ground") significantly explain weak observed transmission.

Identifying the means of enhancing the effectiveness of monetary policy in low-income countries is presented as "an important challenge."
Implicit policy focus areas based on the paper's conclusions:
- Diagnose and address structural impediments to monetary transmission in developing countries.
- Improve empirical methodologies to separate methodological shortcomings from true lack of transmission.
- Prioritize research and policy interventions that strengthen monetary policy transmission channels to reduce stabilization challenges.

Subject: Bank credit, Banking, Exchange rate arrangements, Exchange rates, Financial markets, Foreign exchange, Money, Securities markets, Stock markets
Keywords: aggregate demand, Bank credit, bank lending channel, banks, bond market, Central and Eastern Europe, Central Asia, central bank, developing countries, exchange rate, Exchange rate arrangements, Exchange rates, institutions, interest rate, lending rate, Middle East, monetary aggregate, monetary policy, nominal exchange rate, North Africa, price level, regime indicator, Securities markets, Stock markets, Sub-Saharan Africa, WP

IMF Working Paper No. 2012/143. By Prachi Mishra and Peter J Montiel (June 1, 2012).