We start the chapter with reviewing the empirical literature related to the monetary policy transmission mechanisms, as previous studies provide us with necessary tools and ideas for performing the empirical analysis. Based on the literature reviewed, we choose the appropriate model for our analysis. The next section is devoted to describing the data employed. The final part of the chapter addresses the questions regarding the empirical estimation and interpretation of obtained results.

4.1 Empirical literature review

In our empirical literature part we focus mainly on the studies conducted in regard to transition and emerging economies. The cases of developed countries are discussed to give the general idea about the variety of results between transition and developed country cases reached in empirical analysis of transmission mechanisms. We did not include all research examined by us regarding the monetary transmission, but those which can be seen as representatives to other similar studies.

Mark Gertler and Simon Gilchrist (1993)

This paper was one of the first analyses conducted regarding the role of credit market imperfections in monetary transmission, when debate on this topic was heating. The authors analysed the responses of different forms of credit as well as different type of borrowers to the monetary shocks and found two ways of relevance of credit market imperfections to the transmission mechanisms: (1) certain type of borrowers (mainly small firms) may be forced to rely on bank credit as a result of credit market imperfections; (2) the same type of borrowers may become excessively sensitive to movements in interest rates (the authors used a term “excess sensitivity hypothesis”, in which frictions in the credit market may amplify the distortions in borrowers’ spending decision, that can offer explanation for the second point).

Moreover, by conducting an empirical analysis they showed sharp differences in behaviour of large and small firms. Following the monetary tightening, bank loans to small firms declined while bank loans to large firms increased. The offered explanations suggested that large firms try to smooth the impact of declining sales by using bank loans or accessing short term credit markets, whereas small firms may not have access to these facilities, even though they might suffer large drops in sales, which leaves small firms with the only option of cutting the production. So, all again comes to credit market frictions, where imperfect information may lead to these types of outcomes.

Ben S. Bernanke and Mark Gertler (1995)

In this well cited paper the authors argued that the transmission mechanism had been treated as a “black box” by empirical studies, as there were shortcomings of explanations. For instance, the authors provided counterarguments regarding the magnitude of effects on spending caused by interest rate shock, mentioning the common finding that variables such as lagged output or cash flows have larger effect on spending.

Moreover, in order to examine how the traditional monetary transmission facts are hold, such as the directions of output and price movements, as well as their lagging periods, the authors undertook an empirical analysis, employing VAR method, in which a federal funds rate was used as an indicator of the stance of monetary policy. The results obtained were in line with conventional facts, namely, the decline in GDP as a response to monetary tightening begins after around four months later, whereas the price decline is lagged around a year.

The authors reached a conclusion, saying that as a part of credit channel, the role of the bank lending channel had been diminishing over time, mainly due to the financial innovations and deregulation. Similar conclusion was reached by Mishkin (1996) regarding the bank lending channel in the United States, due to the changes in the regulatory framework and changes in traditional bank lending business. At this point we have to note that this is not true for Uzbekistan, where capital markets are in very early stage of development and banks are still the main player in the intermediation process.

Another point made by the authors that is notable to mention, though not fully related to our analysis, goes to the forecasting power of credit aggregates. The authors warned against treating credit aggregates as an independent causal factor affecting the economy, arguing that credit is not a primary driving force, but the credit conditions are (e.g., measure by the external finance premium).

Veronica Babich (2001)

In this paper the author examines monetary policy mechanism in Latvia for the sample period of 1992–2000, employing narrative approach instead of standard VAR method, which makes it worthy of a mentioning.

In order to investigate different monetary channels the author puts forward several hypotheses regarding these channels and tests them with different means. For example, the author looks tests interest rate hypothesis by looking at presence of “abnormal” increases in interest rates following the monetary shocks. The findings suggest that transmission is working through interest rate and credit channels, but the effects on output and prices seems to be weak or even non-existent.

Igor Vetlov (2001)