Policy Papers No. 3 - The transmission mechanism of monetary policy in emerging market economies

January 1998

Introduction

Economists do not agree about how monetary policy affects the economy. Different observers weigh in different ways the various specific channels through which monetary policy works. Views diverge even about the monetary transmission process in individual industrialised nations, the subject of decades of theoretical and empirical research; the process in developing countries is still more uncertain.

Yet an understanding of the transmission process is essential to the appropriate design and implementation of monetary policy. Because changes in the structure of the economy - including changes in balance-sheet positions, in financial sector technology and institutions, or in expectations concerning future policy - tend to alter the economic effects of a given monetary policy measure, central banks need to be alert to the impact of structural change. They need to be able to continuously reinterpret the channels of transmission of monetary policy.

These important questions were discussed by a small group of senior central bankers at the BIS in January 1997. Two days of very lively debate revealed not only much common ground but also important differences. Much depended on the specific context in which monetary policy was framed: the historical record of inflation; the nature and depth of the financial system; the international financial background; and so on. The first paper provides an overview of some of these issues and tries, where possible, to delineate the differences between countries. The country papers that follow highlight the main experiences of specific countries.