Monetary Policy Transmission and the Impact on Financial Markets, Inflation and the Real Economy

Abstract

The relationship between macroeconomic variables and asset prices varies over time. Recent research points to monetary policy as an important driver of this dynamic relationship. On the one hand, most central banks pursue a mandate that takes into account expected inflation and some measure of the expected output gap. On the other hand, realized inflation and output gap are influenced by monetary policy. The main part of this paper provides an overview of the most important transmission channels of conventional and unconventional monetary policy (and their potential impact on asset prices). The current environment of low to zero interest rates challenges the traditional transmission of monetary policy. However, recent academic research suggests that the central bank is not armless in such an environment. Unconventional monetary policy has been adopted by most developed markets central banks since the start of the Great Financial crisis. This paper also reviews potential limits and side-effects of such policies. Finally, some policy implications of tapering are presented.