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Unraveling the Monetary Policy Transmission Mechanism in Sri Lanka

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  • Manuk Ghazanchyan

Abstract

In this paper we examine the channels through which innovations to policy variables— policy rates or monetary aggregates—affect such macroeconomic variables as output and inflation in Sri Lanka. The effectiveness of monetary policy instruments is judged through the prism of conventional policy channels (money/interest rate, bank lending, exchange rate and asset price channels) in VAR models. The timing and magnitude of these effects are assessed using impulse response functions, and through the pass-through coefficients from policy to money market and lending rates. Our results show that (i) the interest rate channel (money view) has the strongest Granger effect (helps predict) on output with a 0.6 percent decrease in output after the second quarter and a cumulative 0.5 percent decline within a three-year period in response to innovations in the policy rate; (ii) the contribution from the bank lending channel is statistically significant (adding 0.2 percentage point to the baseline effect of policy rates) in affecting both output and prices but with a lag of about five quarters for output and longer for prices; and (iii) the exchange rate and asset price channels are ineffective and do not have Granger effects on either output or prices.

Suggested Citation

  • Manuk Ghazanchyan, 2014. "Unraveling the Monetary Policy Transmission Mechanism in Sri Lanka," IMF Working Papers 14/190, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:14/190
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    Keywords

    Econometric models; Central banks and their policies; Financial markets; Monetary transmission mechanism; Monetary policy; Monetary aggregates; Sri Lanka; Vector autoregression; Central Bank Policies; money market; inflation; money supply; monetary transmission; General Equilibrium and Disequilibrium: Financial Markets; Open Economy Macroeconomics; Monetary Policy (Targets; Instruments; and Effects);

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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