Moldova’s Monetary Policy Transmission Channels Under Scrutiny

A recent analysis by the International Monetary Fund (IMF) has shed light on the effectiveness of Moldova’s monetary policy transmission channels in the aftermath of a major banking fraud. The study found that the response of inflation weakened considerably, with only a peak decrease of 0.2 percent after five quarters.

Interest Rate Channel

The interest rate channel, which transmits policy rate changes to market rates, showed mixed results. While short-term transmission weakened after the banking fraud, long-term transmission remained solid. The analysis found that the policy rate affects money market, T-Bill, deposit, and lending rates, but not vice versa.

• Autoregressive distributive lag (ADL) regression analysis estimated the size of the policy rate’s impact on market rates, revealing a significant decline in short-term pass-through after 2015.
• The study found that the policy rate affects money market, T-Bill, deposit, and lending rates, but not vice versa.

Banking Lending Channel

The banking lending channel, which links monetary policy to bank lending and liquidity constraints, was found to be inactive during the second subperiod. The injection of liquidity and efforts to clean up the banking sector following the fraud were likely responsible for this inactivity.

Exchange Rate Channel

Transmission via the exchange rate channel remains weak due to low capital mobility and exchange rate management. A comparison of impulse responses with and without including the exchange rate found that the difference was not substantial, indicating a generally weak transmission through this channel.

FXIs and Exchange Rate Management

• The degree of exchange rate management in Moldova is moderate at medium frequencies but much higher at high frequencies, potentially harming warranted adjustments in the exchange rate.
• A simple index of exchange rate management constructed using quarterly data shows that Moldova’s level of exchange rate management is moderate and comparable to other emerging economies.

Conclusion

Moldova’s monetary policy transmission channels have been significantly impacted by the banking fraud. While some channels, such as the interest rate channel, show signs of recovery, others, like the banking lending channel, remain inactive. The exchange rate channel remains weak due to exchange rate management and low capital mobility. To improve the effectiveness of monetary policy, policymakers should carefully evaluate and manage trade-offs between reducing excess exchange rate volatility and allowing warranted macroeconomic adjustments via the exchange rate.

Source: International Monetary Fund (IMF)