Monetary policy behaves in a forward-looking manner to influence the economy due to uncertainty and time lag of the effects of its policy actions. Therefore, the central bank’s ability to achieve the targeted goals is highly dependent on how reliable the transmission process is. This paper attempts to examine the effectiveness of monetary policy transmission mechanism in a small open economy, in the case of Mongolia. It employs a structural vector autoregression (VAR) model, which has a block exogeneity of a small open economy and uses two different identifications, the recursive and sign restrictions. The results suggest that the bank lending channel is the most effective transmission mechanism in Mongolia and operates as predicted by theory. We find that the interest rate channel works as influencing both price and output. The exchange rate has an immediate significant pass-through to price level; however, the effect on the real output is unclear. The effects of monetary policy shock on the interest rate and the exchange rate are sensitive to different identification schemes used. The transmission from monetary policy shock to interest rate is stronger in the recursive model but weaker in the sign restriction model. However, the transmission from monetary policy shock to exchange rate is weaker in the recursive model but stronger and persistent in the alternative model. Also, it is found that, with small open economy restrictions, the model resolves the exchange rate puzzle often found in small open economies.



Downloads Statistics

Download Full History