This paper surveys the evidence on the effectiveness of monetary transmission in developing countries. We summarize the arguments for expecting the bank lending channel to be the dominant means of monetary transmission in such countries, and present a simple model that suggests why this channel may be both weak and unreliable under the conditions that usually characterize those economies. Next, we review the empirical methodologies that have been employed in the recent literature to assess monetary policy effectiveness, both in developing countries as well as in industrial and emerging economies, essentially based on vector autoregressions (VARs). It is very hard to come away from this review of the evidence with much confidence in the strength of monetary transmission in developing countries. We distinguish between the 'facts on the ground' and 'methodological deficiencies' interpretations of the absence of evidence for strong monetary transmission. We suspect, however, that 'facts on the ground' are indeed an important part of the story. The fact that a wide range of empirical approaches have failed to yield evidence of effective monetary transmission in developing countries, and that the strongest evidence for effective monetary transmission has arisen for relatively prosperous and more institutionally-developed countries such as some central and Eastern European transition economies (at least in the later stages of their transition) and Tunisia, makes us doubt whether methodological shortcomings are the whole story. If this conjecture is correct, the stabilization challenge in developing countries is acute indeed, and identifying the means of enhancing the effectiveness of monetary policy in such countries is an important challengedeveloping countries; exchange rate; institutions; monetary policy
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