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Monetary Transmission
Mechanisms: A Look at the Baltic Economies Over the last decade the three Baltic countries have been regarded as notable examples of successful macroeconomic stabilization programs and the subsequent exercise of monetary policy. Three separate studies presented in Baltic Economic Trends (2001, no. 2) look at the goals and instruments of monetary policy in Estonia, Latvia, and Lithuania and investigate the importance of different monetary transmission mechanisms. Currency board arrangements, introduced in Estonia in 1992 and in Lithuania in1997, have a major influence on monetary policy. Latvia has pegged its exchange rate to the SDR currency basket since 1994. As of mid-2001 the main goal of Estonia’s monetary policy has been to maintain the stability of the national currency, while in Latvia and Lithuania the goal is price stability. As Lithuania operates under a currency board, one might expect that the Bank of Lithuania would have a similar goal to its Estonian counterpart and regard stability of the national currency as its main objective. However, as the Lithuania study points out, Lithuanian policymakers are eager to exercise active monetary policy, which explains their concern about price stability. Because of their currency boards the only monetary policy instrument that is actively applied in Estonia and Lithuania is the reserve requirement. This implies that most monetary policy effects come through the exchange rate window, which affects base money. In contrast, the Bank of Latvia is not constrained by a currency board, and therefore achieves its objective of price stability by intervening in the foreign exchange market and setting interest rates. As their main contribution, the studies identify the channels of monetary policy transmission and assess the importance of different channels in Estonia, Latvia, and Lithuania. The authors use different methodologies to achieve this goal and make the following observations:
The Latvia and Estonia studies also point out that the effects of existing transmission channels on the real economy are small and short-lived. This is in line with findings for other emerging markets around the world. Most important, the studies raise new questions about monetary policy in the Baltic states that may stimulate further work on this topic. A closer look is needed to confirm and expand upon the findings of these studies. Also, the three studies do not formally consider the effects of asset price channels and expectations, although the Lithuania study does provide some discussion of the effect of expectations. Future research could aim at filling this gap. Finally, when evaluating and interpreting these studies one should keep in mind the challenges that such studies face in the Baltic states. First, even in industrial countries economists do not agree about the methods to use when examining their monetary transmission mechanisms. Second, the short history of monetary policy in the transition economies and the enormous structural changes these economies have experienced make identifying potential monetary policy shocks and their long-run effects particularly difficult. The authors of the original three studies summarized here were Raoul Lättemä and Rasmus Pikkani of the Bank of Estonia; Veronica Babich of the International Graduate Program, Stockholm School of Economics; and Igor Vetlov of the Bank of Lithuania. Baltic Economic Trends is a publication of SITE and the Baltic International Centre for Economic Policy Studies (BICEPS), a new Riga-based policy and research center launched by SITE last spring (see www.biceps.org). Rudolfs Bems, a PhD candidate at the Stockholm School of Economics, is a research associate of SITE and BICEPS. He can be reached by email at rudolfs.bems@hhs.se |
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