Effectiveness of Monetary Policy on Inflation Control and Economic Growth in Bangladesh: A Comparison Between Reserve Requirement and Bank Rate

Abstract

The question of the monetary policy effectiveness and the choice of appropriate policy tools to control inflation and promote economic growth has been the subject of long-standing debate. This comes after highly divergent empirical results on this topic in both rich and developing nations. Particularly in emerging nations like Bangladesh, where financial markets are still in their infancy, the problem is more acute. The purpose of this study, thus, is to complement the extant literature by further assessing the efficacy of monetary policy instruments in Bangladesh. The study specifically looks into how ‘bank rate’ and ‘reserve requirement’ affect inflation and economic growth. Using data on Bangladesh from 1972 to 2021, we run a regression applying a system of two equations that takes into account the simultaneity of inflation and GDP growth. Additionally, we estimate a vector autoregressive (VAR) model to see their responsiveness to a shock in ‘bank rate’ and ‘reserve requirement’. The study found bank rate to have a positive effect on inflation as well as GDP growth, suggesting that tight monetary policy is counter-effective in curbing inflation in Bangladesh. While the reserve requirement negatively affects GDP growth, it does not exert any impact on inflation. The findings suggest that the monetary authority should combine different policy instruments rather than relying just on one particular policy tool to concurrently achieve its dual goals of promoting economic growth and price control.