Exchange Rate And Central Bank Intervention In India: An Empirical Analysis

The transmission mechanisms of monetary policy through commercial banks captured great attention by academics and central bankers. Despite the huge volume of research, there is no absolute agreement about the impact of the change in the monetary policy on commercial banks. With reference to the bank lending channel theory, this study aims at detecting the long- and short-run impacts of four monetary policy tools exploited by the central bank of Lebanon to guide banks who are lending to the private sector. The study covered the period January 1992-December 2016 using monthly data. The aggregate credit granted to the resident private sector was used as the dependent variable, while bank capital, money supply, interest rate, and the inflows of non-resident deposits serve as independent variables. The Vector Error Correction Model (VECM) was adopted in this study as it does not require the variables to be originally stationary. This model is able to reveal the potential long-run causal relationship between exploited time series. Moreover, the Wald test was performed as a complementary test to examine the existence of short-run effects on bank credit. The Vector Error Correction Model revealed a long-run impact running from money supply, while the other three variables did not transmit changes in monetary policy towards bank credit. Besides, the Wald test has shown a short-term impact running from non-resident deposits towards bank lending. Additionally, the Granger causality test demonstrated that non-resident deposits have a causal effect on bank credit, thus it helps in predicting the future trend of bank lending. In contrast, both bank capital and interest rate didn't have any significant effect on bank lending behavior in Lebanon on both short- and long-run. The obtained results have important policy implications which suggest that if monetary policy aims at expanding (contracting) bank lending through monetary easing (tightening), it should increase (decrease) money supply to achieve a long-run impact. However, it has to encourage (discourage) the inflow of non-resident deposits to achieve a short-run impact. Additionally, the results suggest that in Lebanon, changes in bank capital and interest rate will not cause shifts in the supply of loans.