Monetary policy transmission in Georgia: empirical evidence

The strength of monetary policy transmission mechanism is what defines central banks’ ability to influence a real economy and overall prices. This is what we analyze empirically within this paper. Namely, using structural vector autoregressions and based on data since 2009 when the NBG switched to an inflation targeting regime, we estimate the strength of interest rate and exchange rate channels in Georgia. The results suggest that both are relatively strong. Namely, an increase in interest rates seems to generate all three: smaller output gap, exchange rate appreciation and, consequently, lower inflation, underlining the improved transmission mechanism since the estimates from a decade ago. The reaction of inflation to an interest rate change peaks after 4 quarters, in line with other studies as well as the NBG’s communication. Moreover, a variance decomposition analysis shows that inflation is mostly driven by supply shocks with demand shocks having only a negligible effect. In principle, this may be in line with the presumption that it is the central bank’s systematic reaction function that neutralizes the effects of demand shocks on inflation, leaving the supply side as the major driver of inflation data.