Financial globalisation: key trends and implications for the transmission mechanism of monetary policy

Abstract

It is widely acknowledged that the transmission mechanism of monetary policy will evolve as domestic financial markets develop and mature. This development will in turn affect the relative effectiveness of different monetary instruments. Thus the interest rate channel of monetary policy will tend to be weak when domestic bond markets are underdeveloped and banks dominate intermediation of short-term domestic credit and foreign currency denominated funds. In this setting, monetary policy will mainly affect the economy through exchange rate management and/or changes in the domestic money supply. Direct measures, such as politically decided discreet changes in the exchange rate (mostly old style devaluations), and quantitative instruments (eg reserve requirements) will be the dominant tools of monetary policy.