Credit market conditions and impact of monetary policy in a developing economy context

Abstract

This research examines the impact of monetary policy tools on macroeconomic variables through a nonlinear specification of threshold structural vector auto- regression (TVAR) using broad money and reverse repo rate as policy variables and output growth and inflation rate as macroeconomic variables. This research employs net domestic credit and interest rate spread as alternative threshold variables while segmenting the time 2001 m12-2018 m5 as easy and tight credit regimes in Pakistan. This research analyses the generalised impulse response functions for each threshold variable to specify the effects of monetary policy shocks. Current research finds that for one to two years’ time horizon; an increase in broad money has positive and long-time effect on output growth especially when interest rate spread is above its threshold value (i.e. easy credit regime). While a decrease in reverse repo rate brings a short-term positive effect on output growth whereas, an increase in reverse repo rate reduces the inflation for relatively longer time especially when economy is following an easy credit regime. This research identifies changes in broad money as an effective tool to enhance output growth and changes in reverse repo rate to control inflation rate in Pakistan.