Journal Article

Monetary Transmission in Low-Income Countries: Effectiveness and Policy Implications

MONTIEL, PETER J., MISHRA, PRACHI, SPILIMBERGO, ANTONIO

2012

Overview

This paper reviews the monetary transmission mechanism in low-income countries (LICs). We use the standard description of monetary transmission as a benchmark to identify aspects of the transmission mechanism that may operate differently in LICs. In particular, the paper focuses on the effects of financial market structure on monetary transmission. The weak institutional framework prevalent in LICs drastically reduces the role of securities markets. Consequently, traditional monetary transmission through market interest rates and market-determined asset prices are weak or nonexistent. The exchange rate channel, in turn, tends to be undermined by heavy central bank intervention in the foreign exchange market. The weak institutional framework also has the effect of increasing the cost of bank lending to private firms. Coupled with imperfect competition in the banking sector, this induces banks to maintain chronically high excess reserves and to invest in domestic public bonds or (when possible) in foreign bonds. With the financial system not intermediating funds properly, the bank lending channel also becomes impaired. These factors undermine both the strength and reliability of monetary transmission, which has important implications for the conduct of monetary policy in LICs.

• Publisher: Palgrave Macmillan,Palgrave Macmillan UK,Palgrave Macmillan Ltd. (Springer)
• Subject: Aggregate demand / Arbitrage / Assets / Bank lending channels / Bank loans / Bank portfolios / Banking / Banking policy / Bonds / Capital Markets / Central banks / Commercial banks / Competition / Cost / Developing countries / Economic Policy / Economics / Economics and Finance / Emerging markets / Federal Reserve monetary policy / Financial market / Financial markets / Financial systems / Forecasts and trends / Foreign exchange / Foreign exchange market / Foreign exchange markets / Foreign exchange rates / Government securities / Interest rates / International Economics / International finance / LDCs / Loans / Low income groups / Macroeconomics / Macroeconomics/Monetary Economics//Financial Economics / Market structure / Markets / Monetary policy / Monetary policy transmission mechanisms / O11 / O16 / Organizational effectiveness / Prices / Public finance / Reliability / Securities / Securities markets / Stock markets / Studies / Transition economies / Treasury bills