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Monetary transmission mechanism is the process through which monetary policy decisions are transmitted into changes in real GDP and inflation. This model has focused on financial market prices- short-term interest rates, bond yields, and exchange rates. To make clear the consequence of a change in monetary policy on real GDP and inflation using a financial market prices framework, it is usually essential to spotlight on at least three types of prices: exchange rates, long-term interest rates and short-term interest rates.
The Output Composition Puzzle: A Difference in the Monetary Transmission Mechanism in the Euro Area and United States
Now we want to place comparison of certain key macroeconomic features of the transmission mechanisms of monetary policy between the United States and the euro area. We go to in a particular direction in steps. Researchers use a small set of VAR models for the two areas. They find that, the main macroeconomic facts are similar. Specifically, after a monetary shock, real GDP displays a humped-shaped profile, returning to baseline, whereas the price level diverges gradually but permanently from the initial value. Thus, the consensus on the way monetary policy operates in the U.S. has held up through the long business cycle expansion of the 1990s. Moreover, the consensus view seems to well describe the euro area facts too. Nevertheless, prior work has paid relatively little attention to the underlying adjustments that accompany the change in output. In this respect the two areas differ. In particular, after a change in monetary policy the role of household consumption in driving output changes is greater, and that of investment smaller, in the U.S. relative to the euro area. This difference is present in VAR estimates and those of large-scale structural econometric models. We call this the "output composition puzzle." To explore and explain the puzzle we first make a tentative assessment of whether the puzzle is more likely due to divergent behavior of consumers or firms. It appears to us that the consumers are responsible for the differences. Unfortunately we do not have a exact explanation for why this is the case. It appears that disposable income may be less responsive to monetary changes in the euro area than in the U.S. We were motivated to make this comparison by the hypothesis that
social safety net in Europe might cushion the effects of monetary policy on consumption more there. It appears that movements in consumption relative to disposable income are larger in the U.S. too. Explaining this finding and sharpening the tests of the conjecture about the importance of the social safety net are an obvious next step.
The Monetary Transmission Mechanism in Bangladesh: Bank Lending and Exchange Rate Channels
The country approved the FSRP in the early 1990s. An assessment of the empirical evidence has been instituted through the unconfined vector auto regressions (VARs) approach using quarterly data for the period of July-September 1979 to April- June 2005. The results of the empirical analysis suggest weak existence of both bank lending and exchange rate channels in the Bangladesh economy for the full-sample period as well as in the sub-sample period (JanuaryMarch 1990 to April-June 2005). The excess liquidity position in the banking system as well as a significant share of net government borrowing in reserve money in most years partly counteract the efficacy of monetary policy actions. Therefore, the observation regarding the existence of bank lending channel is non-existent in Bangladesh. In Exchange Rate Channel (1990:1-2005:2) the reserve money has a momentous explanatory power of forecasting the movements in nominal exchange rate. The movement in aggregate output, on the other hand has a significant explanatory power of forecasting the future pathway of prices as well as nominal exchange rate. The response of prices to imports is negative and significant in the 1st quarter and exports respond positively to nominal exchange rate only in the 2nd quarter. So, we can conclude that, in Bangladeshs economy there is a weak existence of both bank lending and exchange rate channels for the full-sample period (i.e., July- September 1979 to
April-June 2005) as well as in the sub-sample period (i.e., January- March 1990 to April- June 2005).
Exchange Rates: A reduction in the domestic interest rate due to an easy monetary policy encourages a net outflow of capital. In an economy with substantial cross border mobility of capital, this puts pressure on the balance of payments such that the domestic currency depreciates. Domestic prices of importable rise while the international prices of exportable fall. The heightened competitiveness of the domestic goods raises domestic production, reduces imports and increases exports thus improving the current account balance to offset the reduction in the capital account. To conclude, it should be emphasized that the transmission mechanism of monetary policy is seldom as clear cut or predictable as outlined above. Monetary policy works with a substantial lag. While the foregoing discussion suggests how the policy is transmitted to the wider economy, it is quite possible that the operation of the other factors may blunt or even reverse the impact of the policy.
REFERENCES:
1) John B. Taylor, The Monetary Transmission Mechanism: An Empirical Framework, The Journal of Economic Perspectives, Vol. 9, No. 4 (Autumn,
1995), pp. 11-26 2) Michael Ehrmann and Andreas Worms, Bank Networks and Monetary Policy Transmission, Journal of the European Economic Association, Vol. 2, No. 6 (Dec., 2004), pp. 1148-1171
3) Shamim Ahmed and Md Ezazul Islam,The Monetary Transmission Mechanism in Bangladesh: Bank Lending and Exchange Rate Channels, The Bangladesh Development Studies, Vol. 30, No. 3/4 (September-December 2004), pp.31- 87