Monetary Transmission Channels In Bangladesh: Evidence From A Floating Exchange Rate Regime

The intention of this study is to examine the effectiveness of the monetary transmission channels in Bangladesh.A five-variable unrestricted V ector Auto Regression (VAR) technique is used to examine the relative effectiveness of monetary transmission channel using quarterly data for the sample period from 2004.M7 to 2016.M1. Bangladesh has initiated several policy reforms in monetary policy and exchange rates since 2002 to increase the transparency and efficacy of the monetary transmission channels. For example, there was a significant change in the policy level in Bangladesh at the end of May 2003, when Bangladesh entered into the flexible exchange rate regime.Repurchase Agreement (Repo) and Reverse Repo were introduced in July 2002 & April 2003, respectively for banks and financial institutions as an indirect monetary policy tool for day-to-day liquidity management in response to temporary and unexpected disturbances in the supply of and demand for money. Various government treasury bills have been used to conduct an open market operation to alter money to its desired level. In this backdrop, to assess the policy effectiveness on goal variables, several monetary transmission channels have been analyzed e.g., the interest rate or money channel, bank lending or credit, and the exchange rate channel.The Impulse Response Functions (IRFs) and Variance Decompositions (VDCs) derived from VAR show that money supply and the policy rates both have significant impact on output and the price level in Bangladesh implying that monetary transmission channels are effective in influencing macroeconomic variables particularly output and inflation. The VDCs and IRFs derived from from VAR show that an increase in money supply tends to increase GDP growth, decreasesthe lending rate and increases private sector credit. On the other hand, an increase in the policy rate decreases inflation and also decreases GDP growth. Transmission channel through the real exchange rate increase exports, which in turn increase output. Therefore, the polciy implications of this study is monetary authority can use money suppy and the policy rate to increase output and control inflation in Bangladesh.