The Monetary Transmission Mechanism in the Czech Republic (evidence from VAR analysis)

Abstract

Due to significant lags between a monetary policy action and the subsequent responses in the economy, understanding the transmission mechanism is of primary importance for conducting monetary policy. This paper analyses the monetary policy transmission mechanism using VAR models - the most widely used empirical methodology for analyzing the transmission mechanism in the Czech economy. Using the VAR methodology, the paper tries to evaluate the effects of an exogenous shock to monetary policy. The results show that an unexpected monetary policy tightening leads to a fall in output, whereas prices remain persistent for a certain time. The exchange rate reaction then heavily depends on the data sample used. Although it is clear that due to the rather short time span of the data, the results should be taken with caution, they at least show that the basic framework of how monetary policy affects the economy does not differ significantly either from what would be predicted by the theory or from the results obtained for more developed economies.

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