The interest rate sensitivity of output and prices with different levels of financial inclusion

Abstract

Purpose The purpose of this paper is to evaluate the interest rate (IR) sensitivity of output and prices in developing economies with different levels of financial inclusion (FI) for the period 2007Q1–2017Q4. Design/methodology/approach By using the PCA method to construct an FI index for each country, the author divides the sample into two groups (high and low FI levels). Then, with panel vector autoregressions on per group estimated to assess the strength of the impulse response of output and prices to IR shock. Findings The findings show that the impact of an IR shock on output and inflation is greater in economies with a higher degree of FI. Practical implications The finding indicates the link between FI and the effectiveness of IRs as a monetary policy tool, thereby helping Central banks to have a clearer goal of FI to implement their monetary policy. Originality/value This study emphasizes the important role of FI in the economy. From there, an FI solution is integrated into the construction and calculation of its impact on monetary policy, improving the efficiency of monetary policy transmission, contributing to price stability and sustainable growth.