Analyzing the Transmission Mechanisms of Monetary Policy in the Absence of a National Currency

Abstract

This paper investigates and identifies the channels through which external or internal monetary policy shocks can affect the real economy and inflation in Palestine. Two approaches are used: The vector error correction model and ordinary least square simple regression. In estimating the performance of these models, actual quarterly data is used between Q1 2002 and Q2 2009; for the period of Q1 1996 to Q2 2009, a mix of actual and predicted data is used. Empirical results in general indicate that monetary policy shocks have limited influence on economic activities and inflation in Palestine. However, results show that pass-through from domestic lending interest rates of the US dollar (or Jordanian dinar) is higher than for the new Israeli shekel. They reveal a presence of significant but relatively low pass-through for policy rates onto domestic lending interest rates, and therefore, on real economic activities. Israeli monetary policy has a significant impact on Palestinian real economic activities, mainly net exports and on the inflation rate. Furthermore, the exchange rate channel influences GDP by affecting wealth and net exports. Finally, political conditions have had a significant and important impact on the behavior of the Palestinian people by affecting consumption levels.