Challenges of Effective Monetary Policy in Emerging Economies

Modern monetary policy theory and practice have been heavily influenced by the experiences of developed countries, both large and small. A number of these ideas have also made their way into policymaking at central banks in emerging economies, mostly due to the absence of local intellectual alternatives. However, the realities of emerging economies are often at odds with the circumstances of developed economies that provide the backdrop for the intellectual underpinning of modern central banking. Specifically, the compulsions of unique institutional details as well as the thinness of financial markets in the context of increasing global integration often tends to render the monetary transmission mechanism in emerging economies both unstable and nonstandard. The goal of this paper is to highlight the implications of specific institutional constraints and inherited practices that characterize emerging economies. We do so by focusing on India and fleshing out a number of confounding institutional and legacy issues that characterize the policy environment in the country. We then illustrate the consequences of these frictions for the monetary transmission mechanism by exam-