The Effects of Monetary Policy under Different Stages of Economic and Financial Development

【Authors】

MA Yong & LAN Huanqi

【WorkUnit】

Renmin University of China, 100872.

【Abstract】

Monetary policy is a key instrument for macroeconomic management, but its effectiveness in stimulating economic growth appears to decline worldwide as economic and financial systems have become more advanced—a trend particularly pronounced in developed economies. This phenomenon raises critical questions: Why does monetary policy lose potency in more developed contexts? Do higher levels of economic and financial development impede policy transmission? If so, through which channels, and in what direction? Addressing these questions is essential for understanding how development stages shape policy outcomes and for informing more precise policy design and implementation in practice.
This study incorporates economic and financial development into the optimization behavior of microeconomic agents and uses a general equilibrium framework to establish a micro-foundation for understanding the monetary policy’s macroeconomic effects. Empirically, we use cross-country panel data to test the theoretical predictions and derive two key findings. First, expansionary monetary policy stimulates output by promoting capital accumulation. Second, this stimulative effect diminishes in countries with higher levels of economic or financial development. These findings remain robust after addressing endogeneity concerns. Further analysis reveals that financial development appears to mitigate the diminishing output response to monetary easing observed at more advanced stages of economic development.
This study contributes to the literature in two significant ways. Theoretically, we developed a general equilibrium model that explains why monetary policy effects vary across development stages, offering a structural explanation for the empirical patterns observed in recent research. By embedding economic and financial development directly into the model, we developed a framework that better reflects real-world constraints and more clearly links development conditions to policy outcomes. Empirically, our approach moves beyond single-country studies, which often offer detailed time-series insights but struggle to explain cross-country variation in policy effectiveness. By employing cross-country panel data, we control for key national-level factors （such as macro-financial shocks and fixed effects）, allowing for a systematic examination of how monetary policy effectiveness evolves across different development stages. This also helps reconcile conflicting results in the existing literature that rely on samples from different countries or from different periods within the same country.

JEL: E51, E52

【KeyWords】

Monetary Policy, Economic Development, Financial Development, Capital Accumulation