Monetary Policy Transmission in Bangladesh: Evaluating the Most Effective Channels

Abstract

Influencing inflation, employment, and economic growth in aggregate terms, monetary policy is a crucial strategy to govern overall demand within an economy and is sometimes regarded as the prime instrument for maintaining macroeconomic stability. The research intends to analyze the operational framework of monetary transmission mechanisms and find out the best important channel through which monetary policy affects Bangladesh economy. It employs a comprehensive time-series data from 1972 to 2023. The application of vector autoregression models and causal decomposition via variance helps in detailing the dynamic interlinkages among these monetary channels. It thus helps in analyzing the impact of monetary policy on economic variables and the relative importance of different channels in macroeconomic outcomes. Thus, it was found that Bangaldesh's overall monetary policy operation generally functions using the exchange rate channel as the main mechanism of action. Policy shocks made by the central bank in interest rates are better transmitted to the economy through exchange rate changes that affect trade balances, import costs, foreign capital flows, and national competitiveness. The results highlight the necessity of maintaining a well-monitored exchange rate policy to optimize the effectiveness of monetary interventions. Policymakers must focus on exchange rate stability to enhance economic resilience, mitigate inflationary pressures from imported goods, and foster sustainable growth.