Monetary Transmission Mechanism in Sri Lanka: A Comprehensive Assessment with New Evidence

Abstract

This study provides a comprehensive assessment of the transmission of monetary policy in Sri Lanka starting from changes to central bank policy to the response of final target variables-output and prices. As such, the study provides estimates for interest rate pass-through and suggests that pass-through is yet to achieve the completeness except for prime lending rates. Based on the empirical estimates obtained employing both unrestricted and structural vector auto regressions, this study observes that monetary policy in Sri Lanka is quite effective to influence the target variables of the central bank. It also suggests that monetary policy changes affect target variables through different intermediate transmission channels such as bank credit, exchange rates as well as asset prices. These results provide important policy implications for the Central Bank of Sri Lanka in the conduct of monetary policy and assessing its effectiveness.