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MONETARY POLICY TRANSMISSION



  Apr 26, 2024

MONETARY POLICY TRANSMISSION


1. What is monetary policy transmission?

Monetary policy transmission refers to the process by which monetary policy decisions (like changes in interest rates or reserve requirements) affect the economy and price levels. This includes influencing variables such as investment, consumption, employment, and inflation through various channels like bank lending, asset prices, and exchange rates.

2. What is the policy repo rate?

The policy repo rate is the interest rate at which commercial banks borrow money by selling their securities to the central bank of a country. This rate is a tool used by monetary authorities to control inflation and stabilize the currency.

3. Why is full transmission of the repo rate to loan rates important?

Full transmission is crucial because it ensures that the central bank’s policy decisions effectively influence the economic activities by adequately altering the cost of borrowing. This helps in managing economic growth and maintaining inflation within targeted levels.

4. What factors can hinder the full transmission of policy repo rate changes to loan rates?

Factors that can hinder transmission include:

• High levels of non-food credit as a percentage of total credit, which dilutes the impact of repo rate changes.

• Competition from non-banking financial sources that may not adjust their rates in response to central bank policies.

• Structural issues in the banking sector such as high non-performing assets or inadequate capitalization.

5. How can monetary policy transmission be improved?

Improving transmission can involve:

• Strengthening the banking sector’s response to policy changes through regulatory and policy reforms.

• Enhancing market mechanisms to allow for better flow and pricing of credit.

• Developing alternative financing channels to reduce over-reliance on bank credit.

6. What is the impact of ineffective monetary policy transmission?

Ineffective transmission can lead to a disconnect between central bank policies and actual economic outcomes, such as persistently high inflation or inadequate growth. This can undermine the central bank’s ability to achieve its economic objectives and may lead to economic instability.

These FAQs provide a basic understanding of the complexities and significance of monetary policy transmission in influencing a country’s economic trajectory.



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