What’s Different about Monetary Policy Transmission in Remittance-Dependent Countries?

IMF Working Papers, March 1, 2016

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Remittance inflows provide welfare and poverty-reducing benefits for recipient households.
Remittances entail macroeconomic challenges, including:
- Producing Dutch Disease-type effects through their upward (appreciation) pressure on real exchange rates.
- Reducing the quality of institutions.
- Delaying fiscal adjustment.
- Ultimately having an indeterminate effect on long-run growth.
The paper explores an additional challenge for monetary policy: remittances expand bank balance sheets and provide a stable flow of interest-insensitive funding, but they tend to increase banks’ holdings of liquid assets.
Increased holdings of liquid assets:
- Reduce the need for an interbank market.
- Sever the link between the policy rate and banks’ marginal costs of funds.
- Shut down a major monetary policy transmission channel.
The authors develop a stylized model based on asymmetric information and a lack of transparent borrowers.
Econometric analysis provides evidence that increased remittance inflows are associated with a weaker monetary policy transmission.
As independent monetary policy becomes impaired, recipient countries’ behavior is consistent with earlier findings that they tend to favor fixed exchange rate regimes.

Theoretical approach:
- Stylized model grounded in asymmetric information and a lack of transparent borrowers to explain how remittances affect bank behavior and transmission channels.
Empirical approach:
- Econometric analysis examining the association between remittance inflows and the strength of monetary policy transmission.
Core empirical result:
- Increased remittance inflows are associated with a weaker transmission of monetary policy.

Monetary policy effectiveness can be impaired in remittance-dependent countries because remittances:
- Increase banks’ liquid asset holdings and excess reserves.
- Reduce reliance on interbank markets and weaken the pass-through from policy rates to banks’ marginal funding costs.
Institutional and policy responses implied by the analysis:
- Recognition that standard interest-rate-based monetary policy may be less effective where remittance flows are large.
- The finding that impaired independent monetary policy is consistent with recipient countries favoring fixed exchange rate regimes.