Abstract:
Central Bank of Sri Lanka sets price stability and economIc stability as its mam
monetary policy objective goal. Review of past empirical works reveals that no study
has examined the impact of monetary policy shocks on macroeconomic variables,
using a UVAR framework with context to Sri Lanka. This study attempts to identify
the various factors of monetary policy affect on macroeconomic performance in Sri
Lanka. Specific objectives are to examine the impact of monetary policy on economic
growth, inflation and to identify the solutions for mitigating the lack of
macroeconomic performance in Sri Lanka.To that end; researcher uses a five variable
unrestricted VAR model by utilizing quarterly time series data over the period 1978 2015
in order to focus on the impact on small open economy. Real Gross Domestic
Product and Colombo Consumer Price Index were used as non-policy variables.
Broad money supply, interbank call market rate and exchange rate were used as
potential monetary policy indicators. Impulse response functions and variance
decompositions are employed to capture the impact of monetary policy on the
economic growth and inflation. Impulse response for the model with average call
money market rate presents theoretically consistent results for output and inflation.
Broad money supply presents theoretically consistent with output and inflation only
for some periods. One standard deviation exchange rate appreciation has a positive
effect on output only for some periods which indicate theoretical inconsistency.
Negative impact on economic growth rate shows theoretical consistency of the
estimated results only for some periods. One standard deviation exchange rate
appreciation has a significant effect on reducing inflation, in 71h_1 Olh quarter following
the shock. A shock on economic growth rate, average call market rate and exchange
rate it will have 79%, 16% and 3% variation of the fluctuation in economic growth
rate. A shock to economic growth rate will have 96% of variation of the fluctuation in
the inflation rate. At 5% significant level price level, money supply, average call rate
and exchange rate can't jointly cause for econ2mic growth rate. Economic growth rate
and growth of money supply are most important variable of deciding inflation rate.
