Monetary Policy Transmission Mechanism Analysis In Dollarized Economy

The transmission mechanism of monetary policy describes the dynamic stages in which central bank's monetary policies are transmitted to real output and prices.Understanding transmission mechanism of monetary policy and the effectiveness of its channels is a key success for the central bank in conducting a right monetary policy to stabilize macroeconomic stability and sustain economic growth.Recently,there are growing numbers both theoretical and empirical studies related transmission mechanism of monetary policy varies across economies.However,few studies have focussed on dollarized economies and even fewer have covered characteristic of dollarization,independence of monetary policy and structural change in the economy.Few quantitative studies have been conducted regarding monetary policy analysis in Laos,and they do not include a structural model with structure breaks and character of dollarized economy.This study attempts to fill such research gaps.This research studies the monetary policy transmission mechanism in dollarized economy,for the case of Lao PDR.It aims at achieving three main objectives.First,it explore the monetary policy transmission mechanism of monetary policy in Lao PDR in both financial and the goods market.Second,it assess the effectiveness of monetary policy transmission mechanism in the high dollarized environment in Lao PDR and finally,it assess and compare the relative strength of each channel of monetary policy transmission in dollarized economy,which has not been studied previously.To answer the above question,this study uses two difference models based on the dynamic analytical framework of Structure Vector Autoregression(SVAR)model.These model are(1)the model having only macroeconomic variables and the first stage of monetary policy transmission.(2)The model having the macroeconomic variables,the first stage and second stage of monetary policy transmission variables.These two models use the quarterly data spanning from the first quarter of 1995 to the fourth quarter of 2016.In addition,this study uses various of data stability testing to investigate the stationarity for the given time series data.Specifically,this study examines the stability of the variables using ADF(Augment Dickey-Fuller)unit root test and the LM(Minimum Lagrange Multiplier)for one and two structure breaks.These testing given the fact that most time series data have structure breaks in the 1998-2001 and 2008,reflecting that these structural change in the Lao economy due to the effect of Asian financial crisis and the global financial crisis.The outcome of this study illustrate that the Laos' output and price was sensitively fluctuated following foreign shocks includes U.S monetary policy,the world oil price and the world commodity price.Output and price decrease almost immediately in response to the positive shock of U.S contractionary monetary policy,and also increase almost immediately in response to positive shocks of the world oil price and the world commodity price.While monetary channels show less significant role in Lao economy.Among these channels,the exchange rate channel of monetary policy is found to be the most potentially in transmitting to output and price compare to the other channels.The exchange rate shocks explain a great deal of fluctuation in output particularly in the medium run.In addition,a contractionary monetary monetary policy through the interest rate channel is ineffectively in controlling price and inflation in Lao economy,which emphasis the ineffectiveness of monetary policy transmission mechanism in the high-dollarized economy such the case of Lao PDR.In addition,in the analysis of aggregate demand components of the second stage of monetary policy transmission which represented by household consumption and investment in Laos,were also significantly influenced by foreign shocks includes the world oil price and the world commodity price.Household consumption and investment decrease immediately in response to the positive shock of foreign prices.However,response of these demand components seems to be delayed to channels of monetary policy.Household consumption and price took more than three quarters lag after change in interest rate and credit,and more than two quarters lag after exchange rate devaluation.