In the Monetary policy transmission mechanism, explain what could go wrong between the following points
In the monetary policy transmission mechanism, there are several points where things could go wrong. These points include:
1. Central Bank's Policy Announcement: The first potential issue can arise with the initial communication of the central bank's policy decision. If the central bank's communication is unclear or lacks credibility, it could lead to confusion or doubt in the market participants' minds.
2. Banks' Response to Policy Rate Changes: Once the central bank announces its policy decision, commercial banks are expected to adjust their lending and deposit rates accordingly. However, there could be delays or incomplete transmission of these changes to the market. This can happen if banks are hesitant to fully pass on the policy rate changes due to concerns about their profitability, liquidity, or credit risk.
3. Borrowers' Response to Interest Rate Changes: If banks do transmit the changes in policy rates to their lending rates, it is expected to impact borrowers. However, the response of borrowers may not always be as expected. For example, borrowers may not immediately respond to changes in interest rates due to factors like fixed-rate contracts, long-term borrowing commitments, or lack of awareness about the changes.
4. Transmission to Real Economy: The final step in the transmission mechanism is the impact on the real economy. If the policy rate changes do not effectively influence borrowing costs for businesses and households, the changes in interest rates may not lead to desired changes in consumption, investment, or inflation. This can happen if the transmission channels are weak or if other non-monetary factors are dominating the economic conditions.
To understand what could go wrong between these points, economists and policymakers often analyze the "monetary policy transmission channels" specific to a country's financial system. These channels include the interest rate channel, credit channel, and asset price channel, among others. By closely monitoring these channels and analyzing any deviations or disruptions, the central bank can identify potential issues and take corrective measures to ensure the smooth transmission of monetary policy.