Monetary transmission mechanism in Estonia - empirical model

Rasmus Pikkani ()

No 2001-5, Bank of Estonia Working Papers from Bank of Estonia

Abstract: Estonia has conducted effectively monetary policy according to currency board arrangement for nine years already. For this Estonia has traded off its freedom in active monetary policy operations for nominal anchoring economy through exchange rate. In this context Estonian own monetary policy actions could hardly make any difference and Estonian monetary conditions are heavily relying on decisions made by the issuer of anchor currency. At the same time, there are number of factors having influence on the degree of dependence on foreign monetary factors, most important of which is the openness of the economy to all balance of payments flows and the strength of the domestic banking sector. A mix of all possible factors and decision-making rules in the economy specifies directly the speed and the strength of transmission of foreign monetary signal into domestic economy. The aim of the current paper is to study transmission of ECB monetary policy decisions into Estonian economy. Additionally, absorption of unanticipated foreign and domestic monetary shocks are analysed. For this, rather small macroeconometric model with 11 behavioural equations is specified and estimated. Special emphasis is given on the formation of domestic interest rates and on the intermediation of domestic and foreign funds by domestic banking sector over shock periods. As a result, it is found that the transmission of ECB monetary policy actions over European inter-bank money market into Estonian economy is relatively fast. This is probably mostly due to high openness of the economy and to high price and wage flexibility in Estonia.

New Economics Papers: this item is included in nep-cba, nep-fmk, nep-ifn, nep-mac and nep-mon
Date: 2001-10-10, Revised 2001-10-12
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