[Blog] Effectiveness of Monetary Policy

This paper investigates the structural bottlenecks that render conventional monetary policy tools ineffective within the Mauritian economy.  Monetary policy is ineffective because it is wrongly based on the assumption of the existence of these foundational macroeconomic assumptions — namely developed financial markets, smooth transmission mechanisms, capital integration, and exchange rate parity theories.

I claim that local idiosyncratic structural realities undermine the above assumptions. Jankee (2003) highlighted that in the post-financial liberalization period, the abolition of direct banking controls did not lead to competitive efficiency. Instead, it cemented institutional asymmetries, characterized by high market concentration, wide interest spreads, and a structural decoupling of local interest rates from external parity models. Demand-side monetary adjustments are fundamentally mismatched against supply-side vulnerabilities, and I propose a strategic shift toward macroprudential insulation and targeted credit guidance.

The institutional friction between the Bank of Mauritius (BOM) and fiscal planners highlights a structural design flaw rather than a simple communication breakdown. Conventional inflation-targeting frameworks assume an economy driven by domestic demand-side impulses, smooth price discovery, and rapid banking sector alignment. However, when applied to a highly open, small-island developing state (SIDS) characterized by structural trade imbalances, these assumptions result in systemic policy impotence.

A. Developed Financial System & The Post-Liberalization Reality

Conventional monetary policy relies on deep, liquid, and highly competitive financial markets that can propagate central bank liquidity signals instantly. In Mauritius, this assumption fails due to asymmetric banking concentration and structural anomalies highlighted in Jankee’s research on the finance-growth nexus.

• Jankee K (2003) work on Financial Liberalisation and Monetary Control Reform in Mauritius proves that moving away from direct instruments (credit ceilings, interest rate controls) toward market-based mechanisms requires a highly competitive financial network. In Mauritius, financial liberalisation did not automatically lead to an increase in real interest rates or to perfectly competitive deposit mobilization. Instead, the sector is dominated by a tight banking oligopoly. Because of this oligopolistic concentration, commercial banks maintain high interest spreads driven by unidirectional market share power.

When the BOM adjusts liquidity parameters, banks absorb the shock to preserve margins. Instead of expanding productive credit to high-growth, higher-risk domestic enterprises (SMEs, local manufacturing), financial capital pools into low-risk real estate speculation, leaving key sectors credit-constrained.

B. The Broken Monetary Transmission Mechanism

Standard macroeconomic modeling assumes changes in the Key Repo Rate seamlessly transmit t