Financial sector dynamics, monetary policy transmission and central banking: a cross-country analysis

This thesis presents five empirical essays, all of which revolve around issues related to financial sector dynamics, interest rate pass-through, monetary policy transmission and central banking. The first research essay examines the dynamics and determinants of interest rate pass-through within the global context. This study first identifies long run interest rate pass-through in countries and then examines their changes over time. Thereafter, it explores various macroeconomic, financial/banking and institutional/governance determinants of interest rate pass-through. Findings suggest incomplete interest rate pass-through for the majority of countries while pointing to their changes over time. It also finds that amongst various determining factors of interest rate pass-through, financial market development, banking sector market power and central bank transparency remain the key determinants. The second research essay examines whether the dynamic economic and financial environment in an emerging market economy leads to changes in interest rate pass-through while reducing any asymmetries and heterogeneities. This study finds that economic and financial sector changes lead to substantial structural shifts in interest rate pass-through in emerging market economies. The results also suggest that despite there being structural changes, significant asymmetries and heterogeneities in interest rate pass-through exist due to prevailing high market power in the banking markets and also due to the impact of bank-specific characteristics. The third research essay examines issues related to the monetary transmission mechanism in an emerging market economy focusing on the effectiveness of monetary policy, the relative importance of different channels (interest rate, credit, exchange rate and asset prices), the sectoral effects of monetary policy across different financial institutions and the structural changes in the transmission process. The results suggest that market-based indirect instruments of monetary policy appear more effective in a liberalised financial environment, since price-based channels gain much importance. This study also supports the view that large financial institutions (generally banks) can withstand or delay the impact of monetary policy than small or financially vulnerable institutions pointing to substantial sectoral effects of monetary policy. The study also provides evidence on the changes in monetary transmission over time. The fourth research essay focuses on the impact of off-balance sheet banking on the bank lending channel of monetary transmission. This study finds that off-balance sheet banking reduces the effectiveness of the bank lending channel thus creating a buffering effect on monetary policy. It also finds that the buffering effects are substantial for small, highly-liquid and well-capitalised banks. The fifth research essay examines a recently recognised issue in central banking, i.e., central bank financial strength and its implications on inflation outcomes. Empirical estimates indicate that central bank financial strength is negatively associated with inflation suggesting that maintaining the health of the central bank balance sheet remains a vital pre-condition for desired policy outcomes of a central bank. The findings of this thesis provide important policy implications for economic policy makers, particularly for central banks while contributing to the existing academic literature.