Theoretical Review about Monetary Transmission Mechanisms and Their Implications for Development Studies

Abstract

The purpose of this paper is threefold: to review theories of monetary transmission mechanisms, to draw implications for development studies, and to introduce empirical studies of this field.

There are several channels through which monetary shock affects aggregate demand. These are called the “monetary transmission mechanisms”. One traditional mechanism was proposed by Keynes and it emphasizes the role of interest rate. This view, the “money view”, points out that the interest rate of government bonds influences our decision making for investments. The other view provides us with an explanation based on the imperfect information problem in financial markets. This view, the “credit view”, emphasizes the role of credit markets and financial intermediaries.

Since the late 1980 s, many financial economists have asserted that the “credit view” has become useless, because many countries have liberalized or deregulated their financial markets. This led financial intermediaries to have less influence in these countries. If we look at developed countries, there is no objection to the opinion that the “credit view” has become useless, but when looking at developing countries, the “credit view” is more plausible than the “money view”. One reason is that developing countries face a much more severe problem of information asymmetry due to the underdeveloped financial markets. Therefore, the “credit view” provides us with useful explanations when we look at monetary impacts on real economies in developing countries.

In the empirical studies, most of them have focused on developed countries. The result of some empirical studies did not support the “credit view”. On the other hand, some other empirical studies focusing on developing countries supported the “credit view”. This implies that the role of bank loans in developing countries is much more significant for economic stabilization and economic development.