This paper provides a general overview of the ways that macroeconomic policies can advance or retard financial development, as well as of how financial development can affect the functioning of macroeconomic policies, with a specific focus on how it can alter the mechanisms through which central bank actions can influence domestic economic activity. Understanding the latter is important, because a failure to appreciate how the effects of monetary policy are likely to change as the financial system evolves could make the process of financial development and innovation itself a source of macroeconomic instability. The key findings are that the relative importance of alternative channels of monetary transmission is likely to vary in a systematic way over the course of financial development and that financial development enhances the premium on transparency and predictability of monetary policy. Copyright 2003, Oxford University Press.
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