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Journal oJEconomic Perspectives
9
4
Fall 1995
Pagts 11-26
The Monetary Transmission Mechanism: An Empirical Framework
John B Taylor
The purpose of this paper is to present a simple framework for analyzing the monetary transmission mechanism: the process through which mon
etary decisions are transmitted into changes in real GDP and infla
tion. There are, of course, many different views of the monetary transmission mechanism. These views differ in the emphasis they place on money, credit, interest rates, exchange rates, asset prices or the role of commercial banks and other financial institutions.
The particular fiamework presented in this paper is one that has been evolving over the last several years as the result of empirical research by many economists, including myself. Some of this research has been conducted as part of the work constructing structural models of international financial markets as summarized in the empirical review by Bryant, Hooper and Mann (1993) or the theoretical exposition of Henderson and McRibbon (1993). In fact, the monetary fi-amework presented here is inherently international in its scope, with changes in the exchange caf playing a key role in the transmission mechanism. Other research relating to this particular framework has been conducted by those designing structural models for the evaluation of U.S. monetary policy, as exemplified by recent work by Fuhrer (1994).
I argue that the results of this research, while not leading to any single specific mainstream model of the monetary transmission mechanism, have a number of common structural characteristics and thereby constitute a general framework for discussion and analysis. I also argue that the fiamework is a good empirical way to evaluate polity or to assess whether changes in the monetary transmission John B. Taylor is ProJGSSOr oJEoorwmits and Dindor of the Center Jor Economic Policy Raaa>th, Stanjorrl University, Stanford, CalrJ'onria.
mechanism have occurred over time. The framework passes a number of empirical tests quite successfully. Its structure has foundations in economic theory, and its simplifying assumptions closely match the current institutional structure of the world's highly mobile and increasingly securitized financial markets. Moreover, the framework stands up very well against other frameworks that have been proposed, some of which are discussed in this symposium.
I will begin by describing this framework in general terms, and...