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Monetary Policy | Monetary Policy Workings

Monetary Policy Workings

Monetary Policy Transmission Mechanism

Monetary policy transmission mechanism is a process through which the monetary policy triggers changes in macroeconomic aggregates such as aggregate demand, output and prices. The transmission mechanism works through different channels, affects different aggregates and markets, and does so at varied speed and intensity. Identification of transmission channels helps determine the most effective set of monetary policy instruments and decide when to start with its implementation.

The link between the transmission mechanism and monetary policy measures is illustrated by the chart under Monetary Policy Decision-Making and the Transmission Mechanism.

Current and expected monetary policies affect both money market and financial market. Changes in these markets in their turn affect the market of goods and services, and ultimately, aggregate demand, output and prices. Finally, economic activity and inflation have a reverse effect on monetary policy.

Monetary Policy Transmission Channels

Main channels of the monetary policy transmission mechanism are: