Economics Journals| Applied Economics

The IUP Journal of Applied Economics

The Monetary Policy Transmission Mechanism in Papua New Guinea: A Structural Vector Autoregressive (SVAR) Approach

Article Details

Pub. Date	: Oct, 2021
Product Name	: The IUP Journal of Applied Economics
Product Type	: Article
Product Code	: IJAE11021
Author Name	: Mark Ofoi
Availability	: YES
Subject/Domain	: Economics
Download Format	: PDF Format
No. of Pages	: 32

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Abstract

This paper examines the monetary policy transmission mechanism in Papua New Guinea (PNG) and its impact on the business cycle using quarterly data from 1980Q1 to 2016Q3. The paper explains the short-run dynamic relationship amongst key macroeconomic variables using a Structural Vector Autoregressive (SVAR) model in an open economy setting. The paper confirms that changes in global economic conditions are a material cause of fluctuations in the business cycle in PNG. In contrast, domestic monetary policy shocks play a smaller role in generating business cycle variations in PNG. The paper finds that oil price shocks are more important than commodity price shocks or foreign monetary policy shocks in driving domestic fluctuations. Money supply matters in the transmission of monetary policy, while interest rates contribute modestly to explaining changes in output and inflation in PNG. Monetary policy essentially acts as a stabilizer in limiting the contagion effects of external shocks.

Introduction

Central banks use monetary policy to stabilize the economy from large fluctuations in real economic activity and inflation and to sustain economic growth. Most often, interest rates and money aggregates are used to implement this objective, although it can be argued that money aggregates have played a lesser role in recent times (King, 2002). Changes in these variables transmit the stance of monetary policy influencing the level of domestic demand and prices. Monetary policy is transmitted through a number of channels. The more traditional channels are the interest rate, credit, exchange rate, asset price and expectations channels (Mishkin, 1995). The effectiveness of these channels varies across economies depending on their structural settings and macroeconomic framework. For instance, economies with advanced financial markets have a more effective asset price channel: a drop in interest rates raises the value of firms' assets and collateral and their ability to borrow and raise new capital to finance investment projects. This channel is less important for countries with underdeveloped financial systems, where firms are less able to borrow from financial

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