Interest Rate Pass-Through in a Small Open Economy with a Fixed Exchange Rate - The Case of Macedonia

This paper examines the effectiveness and stability of interest rate pass-through in a small open economy with fixed exchange rate focusing on Macedonia during the period of transition, including the recent economic recession. Specifically, we examine the size and speed of adjustment of money market rate and banks' lending rate to changes in the 'cost of funds' rate and their stability by employing two cointegration methods: Dynamic Ordinary Least Squares and Autoregressive Distributed Lag Model. The results reveal the existence of a cointegrating relationship among the interest rate series with an almost complete long-run adjustment. However, the size and speed of short-run adjustment of lending rate is quite low and sluggish, implying that in the short-run, the domestic monetary policy may have a limited impact on the interest rate channel. Regarding the stability of the interest rate pass-through, the empirical evidence is mixed. (C) 2012 Published by Elsevier B.V. Selection and/or peer review under responsibility of the Faculty of Tourism and Hospitality