DOI: 10.12688/f1000research.190048.1 ISSN: 2046-1402

The Impact of Macroeconomic Uncertainty on Monetary Policy Transmission in Sri Lanka: Evidence from a Threshold Vector Autoregression (TVAR) Model

Morawaggoda Kankanamalage Tharaka Nayana Hansi, Prof. D.A.T. Kumari, Prof. Wasanthi Madurapperuma
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This study examines the impact of macroeconomic uncertainty on the effectiveness of monetary policy transmission in Sri Lanka using monthly data from 2001–2025. Over the past two decades Sri Lanka has experienced several episodes of high uncertainty, including the global financial crisis, the easter Sunday attacks, the COVID -19 pandemic, and the economic crisis of 2022, all of which have posed significant challenges to macroeconomic stability and policy effectiveness. Despite a substantial body of literature examining monetary policy transmission in Sri Lanka, limited empirical attention has been devoted to understanding how macroeconomic uncertainty influences the transmission process, thereby reveling an important research gap. In the absence of a comprehensive monthly uncertainty index, this study constructs a proxy measure of macroeconomic uncertainty using inflation and exchange rate volatility. Employing a regime dependent TVAR framework, the findings indicate that the effectiveness of monetary policy transmission varies across uncertainty regime. Impulse Response Function (IRF) analysis reveals a relatively weak output channel, evidence of a price puzzle and transmission lag in the inflation response, comparatively strong exchange rate channel, although the estimated responses exhibit limited statistical significance. Overall, the findings suggest that elevated macroeconomic uncertainty can weaken the effectiveness of monetary policy transmission, highlighting the importance of maintaining macroeconomic stability and strengthening policy credibility to enhance monetary policy effectiveness in Sri Lanka.

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