An analysis of Fiji's monetary policy transmission

Abstract

PurposeThe purpose of this paper is to examine the monetary policy transmission mechanism for the Fiji Islands using a structural vector autoregressive (SVAR) model for the period 1975 to 2005.Design/methodology/approachThe SVAR model investigates how a monetary policy shock – defined as a temporary and exogenous rise in the short‐term interest rate – affects real and nominal macro variables; namely real output, prices, exchange rates, and money supply.FindingsThe results suggest that a monetary policy shock statistically significantly reduces output initially, but then output is able to recover to its pre‐shock level. A monetary policy shock generates inflationary pressure, leads to an appreciation of the Fijian currency and reduces the demand for money. The paper also analysed the impact of a nominal effective exchange rate (NEER) shock (an appreciation) on real output and found that it leads to a statistically significant negative effect on real output.Practical implicationsThe findings of this study should be of direct relevance to the research and policy work undertaken at the Reserve Bank of Fiji.Originality/valueFor a small economy, such as Fiji, where monetary policy is key to sustainable macroeconomic management, this is the first paper that undertakes a dynamic analysis of monetary policy transmission. The paper uses time series data over three decades and builds a structural VAR model, rooted in theory. This paper will be of direct relevance to the Reserve Bank of Fiji. The approach and model proposed will also be useful for applied monetary policy researchers in other developing countries where inflation rate targeting is a key element of the monetary policy setting.