Does Monetary Policy Transmission in Ukraine Go Through the Interest Rates?

The paper investigates the monetary transmission mechanism in Ukraine and in particular studies the relative importance of its interest rate channel (IRC). First, we discuss the essential institutional arrangements associated with conduct of monetary policy. Second, we quantify the IRC by means of semi-structural five-variable VAR model. We use the total reserves of banking system as monetary policy variable and employ a simple model of market for bank reserves to disentangle monetary policy shocks. To assess the relative importance of IRC, we have applied special procedure to isolate the interest rate component of a monetary policy shock in total reserves. We have found some weak traces of interest rate channel, yet have not detected persuasive evidence that the IRC dominates other channels of monetary transmission. Further, we use preferred specifications to conduct a set of policy experiments. First, we consider loosening of reserve requirements of realistic magnitude. Our estimates predicted that a 19 percent hike in total reserves forces interest rate to fall by 4-6 percentage points, prices to rise by 0.2 percent or 0.9 percent depending on the measure and output to expand by 0.2 -0.7 percent (all over 6 to 12 months). Second, we simulate and interpret the working of monetary policy in the presence of some counterfactual shifts in the economy that affect the speed of economy’s adjustment to long-run equilibrium – unfavorable terms of trade shock, persistently higher inflow of capital and liberalization of regulated prices. Finally, we briefly discuss implications of our results for Ukraine’s recent anti-inflation policy