Bank‐lending channel of monetary policy transmission in WAEMU: An estimated DSGE model approach

Abstract This article examines the effectiveness of the banking‐lending channel in the transmission of monetary policy mechanisms in the West African Economic and Monetary Union. We estimated a Dynamic Stochastic General Equilibrium model with an incomplete credit market, where the financial system is based on an active banking sector and the central bank follows a fixed exchange rate regime, using quarterly data from 1985Q1 to 2020Q4. Findings reveal that, first, monetary policy induces an expansionary effect in the real economy when the banking sector loosens borrowing constraints. Second, we found that the banking sector is sensitive to the contraction of monetary policy via its effects on lending rates and deposit rates. Third, findings show that the bank‐lending channel amplifies and propagates monetary policy transmission mechanisms into the real economy. The counterfactual analysis demonstrates that the level of financial depth within the currency union enhances the efficiency of the bank‐lending channel of the monetary policy transmission mechanism. The macroeconomic outcomes and the financial implications of monetary policy via bank‐lending channels are more accentuated for the economies of the currency union with more financial depth than for those with shallow financial sector depth.