It is generally believed that central banks ideally should have a single overwhelming objective of price stability. In practice, however, central banks are responsible for a number of objectives besides price stability, such as currency stability, financial stability, growth in employment and income. Of late, however, considerations of financial stability have assumed increasing importance in monetary policy. The most serious economic downturns in the recent years appear to be generally associated with financial instability.
Monetary policy is known to have both short and long-term effects. While it generally affects the real sector with long and variable lags, monetary policy actions on financial markets, on the other hand, usually have important short-run implications. Typical lags after which monetary policy decisions begin to affect the real sector could vary across countries. It is, therefore, essential to understand the transmission mechanism of monetary policy actions on financial markets, prices and output.
The four monetary transmission channels, which are of concern to policy makers are: the quantum channel, especially relating to money supply and credit; the interest rate channel; the exchange rate channel, and the asset prices channel. Monetary policy impulses under the quantum channel affect the real output and price level directly through changes in either reserve money, money stock or credit aggregates. The remaining channels are essentially indirect as the policy impulses affect real activities through changes in either interest rates or the exchange rate or asset prices. Since none of the channels of monetary transmission operate in isolation, considerable feedbacks and interactions, need to be carefully analysed for a proper understanding of the ...