How does monetary policy shape economic activity in developing countries ?

How does monetary policy transmit through developing economies? New evidence shows that firms do react to both monetary policy contraction and expansion, but not symmetrically. 

Monetary policy is a cornerstone of economic management, yet its effectiveness in developing countries remains a subject of intense debate. Why does it seem to work in some contexts but not others? Three main explanations have emerged to account for the apparent weakness of monetary policy transmission in these economies:

1. The lack of observed effects may simply reflect methodological limitations (Li et al. 2019). Traditional macroeconomic research relies on aggregate yearly indicators that often fail to capture the nuanced adjustments actors make in response to policy shifts.
2. The impact of monetary policy may genuinely be weaker in developing economies due to structural constraints (Mishra et al. 2014). Shallow financial markets, excess liquidity in banking systems, or a lack of credibility can all dampen the transmission of policy signals to the real economy, making monetary tools less effective than in advanced economies.
3. Monetary policy may only reveal its full effects under specific conditions, such as during periods of dramatic tightening when central banks aggressively raise interest rates to combat inflation (Abuka et al. 2019, Willems 2020). In these cases, the effects become more visible, but they often remain obscured during normal times or following modest policy adjustments.

To better understand how monetary policy shapes economic activity, we (Dramé and Léon 2025) adopted a novel approach. Rather than broadly asking whether monetary policy affects the economy, we focused on a more precise inquiry: “Do firm managers notice when monetary policy changes, and do they adjust their behaviour as a result?”