Monetary policy transmission mechanisms in Serbia: evidence from the fully-fledged inflation targeting regime

Abstract

This article examines the effectiveness of monetary transmission mechanisms in the Serbian economy, covering the period from January 2009 (the point at which the formal switch to the fully-fledged inflation targeting regime was made) to December 2013. The results of the recursive VAR models suggest that the exchange rate and credit channels play a major role in the monetary transmission process, whereas this is not true in the case of the interest rate channel. However, the results of the non-recursive VAR models show that the role of the exchange rate has diminished over time. On the other hand, the credit channel has become much more influential. Thus, if one of the overriding objectives of adopting the explicit inflation targeting regime is to enhance the importance of other channels apart from the exchange rate channel, which could make monetary policy more effective in achieving price and financial stability, the switch to the inflation targeting regime is justified.

Keywords:

• Monetary policy transmission mechanism
• recursive VAR model
• SVAR
• price puzzle

JEL classification:

• E52
• E58

Acknowledgements

We would like to express our deepest gratitude to Branimir Jovanović (Visiting researcher at the University of Turin) for invaluable comments and suggestions. All remaining errors are those of authors.

Notes

1. Interested readers can find more details about the VAR methodology in Lütkepohl and Krädzig (2004).

2. Considering that the identification of monetary policy shocks is central to analysis of the monetary transmission mechanism, the choice of an appropriate measure of these shocks is of particular importance. Pétursson (2001) highlights that the ideal measure should be one that is under direct control of the Central Bank and is not affected by changes in the demand for money in the short run. In our case, the repo rate will serve the purpose.

3. The response of the variable observed to the monetary policy shock is said to be statistically insignificant when the baseline is within the 95% confidence band over the duration of the shock.

4. The SVAR specification enables us to analyse the total effect of a monetary policy shock on aggregate credit. However, it cannot provide us with evidence about whether the loan reaction is supply driven (a bank lending channel) or is demand driven (an interest rate channel), or is the result of their simultaneous effects. To disentangle supply from demand effects, further empirical investigation should be aimed at a bank level data.