Monetary Transmission Mechanism and the Role of Transmission Channels

Abstract

Purpose: The study seeks to discuss the transmission mechanism of monetary policy, the role and functioning of various transmission channels and factors affecting the transmission process. Additionally, the paper attempts to study the transmission of monetary policy signals in India following the introduction of EBLR system.

Design/Methodology/Approach: The paper discusses transmission mechanism, the key transmission channels and their effects on different sectors and different variables based on the available literature. In addition, the paper discusses the monetary transmission in India, under the EBLR regime, by analysing the secondary data collected from the RBI reports.

Findings: Monetary transmission process and key channels of transmission are discussed in detail. While interest channel affects output growth and prices through its impact on investment and consumer expenditure, credit channel does so by affecting balance sheet of the banks and net worth of firms. Monetary signals are transmitted to asset market affecting investment and growth through asset price channel while exchange rate channel influences output and prices via effects on net exports and import prices. In India interest rate channel is proved to be the most effective channel of transmission. Monetary transmission has improved following the adoption of the EBLR system.

Originality/Value: With changing financial structure, macro-economic conditions, increasing liberalization and economic integration, monetary transmission mechanism is constantly evolving across countries. In this context, the paper would be useful to study the operation and relative importance of different transmission channels in the ever-changing financial landscape. Additionally, the paper would provide insights into the transmission process under the EBLR regime in India.

Paper Type: Theme Based Paper