Transmission of monetary policy shocks in small open emerging market economies

Abstract

In this paper, we compare the transmission of monetary policy shocks using quarterly data for 13 emerging market economies (EMEs) with that in a benchmark advanced open economy, the United Kingdom, in the periods of inflation targeting (from 1990s onward). To estimate the transmission within a given country, we specify a monetary VAR-model and we extend it with a variable reflecting commodities terms of trade. We identify monetary policy shocks using a sign restriction scheme: a restrictive shock is determined as an unexpected rise of policy rate and reduction of inflation (CPI) and money demand (M2). We apply the Bayesian approach to estimating VARs to address the curse of dimensionality. Our results indicate that monetary policy in EMEs is not less efficient comparable to the U.K.: restrictive monetary shocks decrease inflation but also lead to a slowdown of GDP and stock market outflows. Overall, our findings add to the debate on the real effects of monetary policy surprises with a special attention to a large set of EMEs.