Monetary Policy Transmission Mechanisms in Pacific Island Countries
IMF Working Papers, April 1, 2011
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Bibliographic details
- Authors: Jonathan C Dunn, Matt Davies, Yongzheng Yang, Yiqun Wu, Shengzu Wang
- Published: April 1, 2011
- Series: IMF Working Papers
Summary
- During the global financial crisis, central banks in Pacific island countries eased monetary policy to stimulate economic activity.
- Movements in commercial bank interest rates and private sector credit suggest monetary policy transmission appears to be weak.
- An empirical examination of interest rate pass-through and credit growth confirms weak transmission.
- Factors limiting effectiveness included weak credit demand and underdeveloped financial markets.
- The inflexibility of exchange rates and rising real interest rates also frustrated central banks’ efforts despite a supporting fiscal policy.
- The experience highlights the importance of developing domestic financial markets in the long run and the need to coordinate macroeconomic policies and use all macroeconomic tools available in conducting countercyclical policies, including exchange rate flexibility.
Empirical findings and diagnostics
- Interest rate pass-through: empirical examination indicates weak pass-through from policy rates to commercial bank interest rates (details as summarized in text).
- Credit growth: private sector credit growth movements reinforce the conclusion of weak monetary transmission.
- Observed interactions:
- Commercial bank interest rates movements aligned with policy easing but did not translate into strong credit expansion.
- Private sector credit response was muted, pointing to demand- and supply-side constraints in financial intermediation.
Constraints on monetary policy effectiveness
- Weak credit demand.
- Underdeveloped domestic financial markets.
- Inflexible exchange rate arrangements (conventional peg referenced under subjects).
- Rising real interest rates.
- Limited effectiveness persisted despite supporting fiscal policy.
Policy implications and recommendations
- Develop domestic financial markets to strengthen monetary transmission in the long run.
- Coordinate macroeconomic policies (monetary and fiscal) to enhance countercyclical policy effectiveness.
- Use all macroeconomic tools available, including exchange rate flexibility, when conducting countercyclical policies.