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

Abstract

This paper reviews the monetary transmission mechanism in low income countries (LICs). We use monetary transmission in advanced and emerging markets as a benchmark to identify aspects of the transmission mechanism that may operate differently in LICs. In particular, we focus on the effects of financial market structure on monetary transmission. The weak institutional framework prevalent in LICs drastically reduces the role of securities markets and increases the cost of bank lending to private firms. Coupled with imperfect competition in the banking sector, this means that banks with chronically high excess reserves invest in domestic public bonds or (when possible) in foreign bonds. With the financial system not intermediating funds properly, the traditional monetary transmission channels (interest rate, bank lending, and asset price) are impaired. The exchange rate channel, on the other hand, tends to be undermined by central bank intervention in the foreign exchange market. These conclusions are supported by review of the institutional frameworks, statistical analysis, and previous literature.

Inflation in Low-Income Countries

“…In short, Tobin's description of the effects of easing monetary policy under conditions of high liquidity preference as "pushing on a string" may be an especially apt analogy in the case of LICs, and the effects of tightening policy are also likely to be limited. A survey of studies of the strength and reliability of monetary transmission in LICs, by Mishra and Montiel (2013), and the empirical evidence based on a large panel of countries by Mishra et al (2014) are consistent with this perspective.…”

Reactions to Shocks and Monetary Policy Regimes: Inflation Targeting Versus Flexible Currency Board in Sub‐Saharan Africa

“…Therefore, the bank lending channel operates through the supply side (i.e., banks’ supply of loans). Empirical evidence that a bank‐lending channel exists in sub‐Saharan African countries has been presented in several papers, though the effect is likely to be weaker than in other developing and emerging countries (see, among others, Lungu ; Mishra and Montiel ). Bernanke and Gertler () were among the first to identify the main characteristics of a bank‐lending channel, some of which we assume not to be relevant for the African countries.…”

Analysing Monetary Policy Statements of the Reserve Bank of India

“…The important topic of central bank communication has received relatively scant attention in emerging economies, where transmission of monetary policy tends to be less effective due to a host of reasons, including under-developed financial markets, weak institutional frameworks, and imperfect competition in the banking sector (Mishra and Montiel, 2013;Mishra et al, 2012;Bhattacharya et al, 2011). However, recent work by Brandao-Marques et al (2020) shows that having a modern monetary policy framework, such as inflation targeting (IT), matters more for transmission than financial sector development.…”