Monetary Economics

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Economic Liberalization, Monetary Policy and Money Demand in Rwanda: 1980–2005
(AERC, 2010-01-28) Musoni J. Rutayisire
The objective of this study was to estimate a long and short run money demand function in the Rwandan economy. Using the Johansen approach, this paper established that there was a stable long-run equilibrium relationship between the demand for real money balances, real income, the rate of return on foreign financial assets (Libor-London interbank offered rate) and the expected depreciation of the Rwandan franc (RWF). The short-run dynamic model confirmed the stability of this relationship. These results suggest that the monetary aggregate used in this study, M2, is the appropriate monetary target in the Rwandan economy for monetary policy purposes and economic stabilization. The significance of the return on foreign financial assets and of the expected depreciation of the domestic currency demonstrated the importance of the external determinants of money demand in Rwanda and confirmed the hypothesis of currency substitution in the Rwandan economy. Attempts to include various interest rates in the money demand function revealed that these rates were not significant .This was not surprising because interest rates were controlled for most of the sample period. Moreover, the excess liquidity in the banking system in recent years made the interest rate ineffective as an instrument of monetary policy. Finally, another significant finding of this research is the speed of adjustment of the demand for money, following deviation from its long-run equilibrium. As the short-run dynamic model showed, this adjustment period amounts to about three years, which is an indication of the persistence of monetary disequilibrium in the Rwandan economy.
The Effects of Monetary Policy on Prices in Malawi
(AERC, 2020-04-27) Mangani, Ronald
Evidence on the transmission mechanism of monetary policy is quite non-uniform, particularly across countries with different economic structures. Complications to theoretical propositions tend to arise when economies are less market-oriented and less sensitive to policy interventions, when monetary authorities are not adequately independent, or when market-based and administrative policy instruments are used concurrently. It is important, therefore, to appreciate the unique dynamics of the transmission mechanism in any jurisdiction, in order to understand and possibly predict the macroeconomic effects of monetary policy. This study assessed the effects of monetary policy in Malawi by tracing the channels of its transmission mechanism, while recognizing several factors that characterize the economy: market imperfections, fiscal dominance and vulnerability to external shocks. Within the environment of vector autoregressive modelling, Granger-causality and block exogeneity tests as well as innovation accounting analyses were conducted to describe the dynamic interrelationships among monetary policy, financial variables and prices. The study established the lack of unequivocal evidence in support of a conventional channel of the monetary policy transmission mechanism, and found that the exchange rate was the most important variable in predicting prices. Therefore, the study recommends that authorities should be more concerned with imported cost-push inflation rather than demand-pull inflation. In the short term, pursuing a prudent exchange rate policy that recognizes the country’s precarious foreign reserve position could be critical in deepening domestic price stability. Beyond the short term, price stability could be sustained through the implementation of policies directed towards building a strong foreign exchange reserve base, as well as developing a sustainable approach to the country’s reliance on development assistance.
Twin Deficits Phenomenon in the West African Economic and Monetary Union Countries: Panel Data Analysis
(AERC, 2020-04-27) Yeboua, Kouassi
For a long time, the West African Economic and Monetary Union (WAEMU) countries have been experiencing persistently high budget and current deficits. This study was undertaken to empirically test the “Twin Deficits Hypothesis” in these countries. The analysis was conducted within the framework of the Panel Vector autoregressive (VAR) approach over the period 1975–2013. In contrast to the conventional view which claims a one-way relationship between budget and current account deficits, the results show that budget deficits lead to a deterioration in the current account balance, and vice versa (bilateral relationship). We also found that budget deficits have an impact on current account balance mainly through imports
Asymmetric Shocks, Real Exchange Rate Distortions and Options for the Second Monetary Zone in West Africa
(AERC, 2020-04-27) Agu, Chukwuma; Nnamani, Uchenna Alexander
The West African Monetary Zone (WAMZ) has continued to set targets of monetary integration for member states without success. With 2020 set as the new deadline for the attainment of monetary integration in the zone, it is not clear how the feasible this deadline is. It is clear that there are distortions that possibly affect not only the feasibility of enacting the union but also the potential outcome should the leaders decide to ram through the unification without due consideration to these factors. One such factor is exchange rate alignments. This study therefore investigates the presence of real exchange rate misalignments and the effects of such on the macroeconomic stabilities of the WAMZ countries. Due to paucity of data, the study captures only four of the six countries that make up WAMZ – Nigeria, Ghana, The Gambia, and Sierra Leone. It finds that there are misalignments of real exchange rates in all the four countries. These manifest mostly as real exchange rate (RER) overvaluation in two of the four countries, and as RER undervaluation in the other two countries. The RER misalignments and volatilities affect macroeconomic behaviours of the member countries in various ways and to varying degrees. We evaluate the diverse ways these misalignments affect macroeconomic policies and behaviour of the countries and their implications on the integration effort. The study concludes that efforts at stabilizing the macroeconomic fundamentals that determine RER in the WAMZ member states, beginning with monetary policy tools, will be important steps towards instituting a sustainable monetary union.
The Effect of Illicit Financial Flows on Government Revenues in the West African Economic and Monetary Union Countries
(AERC, 2020-07-27) Thiao, Abdou
This is a study of the effect of illicit financial flows (IFFs) on government revenues in the West African Economic and Monetary Union (WAEMU) countries over the 1996–2013 period. The study found that IFFs had a negative and significant effect on government revenues and that this effect was tied to per capita income, corruption and governance. It further highlighted the significance of the per capita income in the relationship between illicit financial flows and government revenues.
The Exchange Rate Pass-Through to Inflation and its Implications for Monetary Policy in Cameroon and Kenya
(2020-09-03) Revelli, Dongue Ndongo Patrick
Understanding how domestic prices adjust to the exchange rate enables us to anticipate the effects on inflation and monetary policy responses. This study examines the extent of the exchange rate pass-through to the Consumer Price Index in Cameroon and Kenya over the 1991-2013 period. The results of its econometric analysis shows that the degree of the exchange rate pass-through is incomplete and varied between 0.18 and 0.58 over one year in Kenya, while it varied between 0.53 and 0.89 over the same period in Cameroon. For the long term, it was found to be equal to 1.06 in Kenya and to 0.28 in Cameroon. A structural VAR analysis using impulse-response functions supported the results for the short term but found a lower degree of passthrough for the exchange rate shocks: 0.3125 for Kenya and 0.4510 for Cameroon. It follows from these results that the exchange rate movements remain a potentially important source of inflation in the two countries. Variance decomposition shows that the contribution of the exchange rate shocks is modest in the case of Kenya but significant in that of Cameroon.
Inflation, Output and Monetary Policy in South Africa
(AERC, 2020-09-12) Ngalawa, Harold; Komba, Coretha
South Africa adopted inflation targeting as its monetary policy framework in February 2000. The country’s monetary authorities, however, have struggled to keep inflation within the targeted 3%-6% band. A review of the literature reveals that an understanding of the inflation-output trade-off is essential for the achievement of price stability. The effects of policy may be different depending on whether the inflation-output trade-off is symmetric or asymmetric; and when it is asymmetric, the outcome may vary contingent on whether the asymmetry is convex or concave. In South Africa, the nature of this relationship is not known. Estimation of the inflation-expectations augmented Phillips curve using the difference Generalized Method of Moments on quarterly time series data for the period 2000:3 to 2015:1 reveals that South Africa’s Phillips curve is concave asymmetric. These estimation results, however, may not be policy-invariant because they are obtained from “highly” aggregated historical data and the model parameters are not structural. Consistent with the Lucas Critique, we formulate a New Keynesian dynamic stochastic general equilibrium model calibrated on South African data. Simulation results of the model show that a negative demand shock reduces inflation and output while a positive demand shock of the same magnitude leads to a smaller increase in inflation and a larger increase in output, confirming the concave asymmetric inflation-output relationship found earlier. Concavity of the Phillip’s curve implies declining sensitivity of inflation to the strength of the economy, suggesting that any given change in inflation requires an increasingly larger adjustment in output.
Modelling Interest Rate Passthrough in Rwanda: Are the Interest Rate Adjustment Dynamics Symmetric or Asymmetric?
(African Economic Research consortium, 2020-11-03) Rutayisire, Musoni J.
The influence of monetary policy depends on the effectiveness of the interest rate pass-through, that is the size and the speed to which changes in the central bank policy actions are transmitted to bank retail interest rates. The objective of this paper is to investigate the relationship between the policy-controlled interest rates (Repo and Treasury bill rates) and the bank interest rates (interbank, deposit and lending rates) in Rwanda with a view to empirically examining the size and speed of the interest rate pass-through in the long run and short run and determine whether the passthrough process is symmetric or asymmetric. The empirical results of the paper, using monthly data covering the period from January 2008 to December 2017, indicate that the interbank, deposit and policy rates are cointegrated, hence a non-linear error correction model has been used to assess the asymmetric adjustment dynamics to long-run equilibrium. By contrast, the lending rates were found to be cointegrated with none of the selected policy rates; hence the interest rate pass-through has been estimated by means of a transformed autoregressive distributed lag model. The empirical results of the study show that the estimated long-run as well as the short-run interest rate pass-through of the selected policy rates to deposit and lending rates is weak and sluggish. Regarding the asymmetric adjustment process of the bank rates, empirical results show that depending on the policy rate, the interbank and deposit rates react differently following a negative and a positive shock in the policy rates; but no evidence was provided for asymmetric adjustment of the lending rates.
Empirical Performances of Divisia versus Traditional Monetary Aggregates in BEAC and BCEAO
(African Economic Research consortium, 2021-01-20) Ndjokou1, Mondjeli Mwa
The purpose of the paper is to evaluate empirical performances of Divisia relative to traditional monetary aggregates in terms of growth and inflation within the period 1992.1- 2009.4 in BEAC2 and BCEAO3 . The methodology of the paper is focused on variance decomposition analysis derived from VAR/VECM specification to evaluate the contribution to price level and real GDP’s fluctuations of each type of monetary aggregate. The following conclusions are derived from the empirical analysis. Traditional monetary aggregates have better empirical performances. In BEAC, traditional M2 perform better in explaining price and real GDP fluctuations. The variations of price level are mostly due to traditional monetary aggregate M1 while simple sum monetary aggregate M2 is the best indicator of real GDP in BCEAO.
Interest Rate Pass-Through in Malawi: Implications for Effectiveness of Monetary Policy
(AERC, 2021-04-19) Chiumia, Austin; Palamuleni, Arnold
This study investigated the interest rate pass-through and its implications for monetary policy effectiveness in Malawi. Using the cost-of-funds approach and monthly data from 2009 to 2015, an autoregressive distributed lag model was estimated. Results suggest that the structure of the banking industry (banking environment) matters. Also, market power is important in understanding the resulting variation in the savings and lending rates across banks in the market as well as the transmission of monetary policy impulses. Overall, our findings suggest that short-term rates as operating target are consistent with inflation targeting as a monetary policy objective.
Regulatory Framework and Microfinance Institutions’ Performance within the West African Monetary Union
(AERC, 2021-05-06) Hadizatou, Ali
This study assessed the performance of microfinance institutions (MFIs) in the West African Monetary Union (UMOA) following a change in regulations and prudential ratios (capital and liquidity). Results of econometric estimations based on data covering the period 2002-2015 showed that the application of the 2007 law did not bring any benefit to the performance of the MFIs. This is because the opportunity cost of holding liquidity when the new law was adopted and the period during which it was effectively enacted was high enough to have a negative effect on return on assets, on the return on equity and on the proportion of loans per capita. During the same period, the minimum capital requirements were of great importance for financial performance, since they led to an accumulation of funds for investment purposes. The relationship between minimum capital and performance remained positive even when different performance indicators and estimation methods were used. However, the effect of liquidity and regulation varied with the estimation method used.
Fiscal Policy and Monetary Integration in the ECOWAS
(African Economic Research Consortium, 2021-08-06) Ony, Kenneth; Umoh, Okon J.
Those with dissenting views regarding the structure of monetary union arrangement in the ECOWAS often argue that the macroeconomic convergence criteria have hampered the ability of countries in the region to stabilize their economies with appropriate counter-cyclical fiscal policy. We tested the empirical merit of this assertion and found no support for this view. Instead, discretionary fiscal policy has actually become counter-cyclical in ECOWAS after the introduction of convergence criteria. In specifics, we found a switch from pro-cyclical fiscal policymaking in the pre-convergence era (1995-2002) to a counter-cyclical fiscal policymaking in the convergence era (2003-2018) in the ECOWAS, and that policy makers in the region respond to initial conditions – apparently taking cue from past (initial) debt and past deficit. The policy import of our result is the need to: (i) introduce more flexibility in fiscal policy making through discretionary fiscal policy that balances the budget (against the constraints imposed by the convergence rules) over the business cycle; and (ii) adopt ‘discretionary fiscal deficit’ to monitor compliance (rather than gross deficit) because it represents effort made to correct excess deficit.
Interbank Market and Effectiveness of Monetary Policy in Malawi
(African Economic Research Consortium, 2021-09-17) Kanyumbu, Esmie Koriheya
The study aimed at investigating how the interbank market affects the monetary policy transmission mechanism in Malawi. To achieve that, the study analysed the nature of the relationship between excess reserves and the interbank market rate and tried to discuss other possible factors that affect the interbank market rates in Malawi and limit the effectiveness of the central bank’s efforts that aim at influencing important interest rates in the economy. The study further analysed the strength and speed at which the interbank market rate affects other money market rates, specifically the lending rate. Using financial markets monthly data for the period 2010:1 to 2018:6, the study applied Ordinary Least Square methods for estimation using Error Correction Model. From the results of the study, it is concluded that the interbank market is the right platform through which the central bank can influence money market rates in the process of monetary policy implementation. Interbank market rates respond to levels of banking system liquidity at a speed that makes sense for monetary policy and they are able to send significant signals to other relevant market rates like lending rates. Drawing from these outcomes, the study recommends continued forecasting and controlling of banking system liquidity by the central bank and establishment of additional factors that affect the interbank market rate and hence limit the central bank’s efforts. For further improvement in the monetary policy transmission mechanism, the study recommends increased knowledge on interbank pricing models for individual commercial banks and research on the informal sector’s reaction to central bank’s policy actions
Banks and Monetary Policy Transmission in the West African Economic and Monetary Union
(African Economic Research Consortium, 2021-11-25) Kanga, Désiré; Kanga, Désiré
This paper aims at examining the role of banks in the transmission of the monetary policy in the West African Economic and Monetary Union (WAEMU). By using a simple theoretical model, this paper shows that improving the quality of institutions and an increase in competition strengthens the transmission of monetary policy while capital requirement behaves like an additional cost to the borrowers. Applying a dynamic panel estimator to a large sample of WAEMU banks, the paper finds that bank lending is sensitive to monetary policy and capital-constrained banks reduce further their lending following a tight monetary policy compared to less capital-constrained banks. Moreover, an improvement in the quality of institutions seems to strengthen the transmission of monetary policy.
The Role of Energy Price Shocks in the Transmission of Monetary Policy in an Inflation Targeting Country: The Case of Ghana
(African Economic Research Consortium, 2022) Harvey, Simon K.; Walley, Bernard J.
Energy inflation has become more volatile and has evolved independently of other components of headline inflation over the years. Therefore, the use of one Phillips curve to capture short-run inflation dynamics may be inadequate in terms of helping the monetary policy authorities to determine the appropriate path of the monetary policy rate. In particular, such an approach may introduce noise into the model system, making it difficult to get reliable forecasts for inflation. We extend the existing New Keynesian model to include separate Phillips curves for energy inflation and non energy inflation. This approach would help the monetary policy authority in Ghana to gain a deeper understanding of how shocks to energy prices affect inflation, thereby leading to informed decisions about the appropriate path of the monetary policy rate in Ghana. We also incorporate a fiscal block to capture the effects of fiscal deficits on inflation in Ghana. We use the extended model to study the transmission mechanisms of the real economy, and of the exchange rate. This analysis allows us to understand the importance of these shocks in explaining inflation developments in Ghana and their implications for monetary policy. The results are mixed, indicating that isolating energy price from the rest of prices in the CPI basket does not necessarily improve the forecasts of the key macroeconomic variables, and will therefore not necessarily lead to better policy outcomes.
Inflation Dynamics in Zambia
(2022-04) Chipili, Jonathan M.
This study assesses the drivers of overall inflation in Zambia over the period 1994q1- 2019q4. A single-error correction model is used in which the underlying determinants of both food and non-food components of inflation as well as supply constraints are incorporated in the overall inflation equation. The empirical results show that, in the long-run, the sources of overall inflation are determined in the external sector market where the exchange rate and world non-food prices drive domestic prices. In the short-run, overall inflation is influenced by the depreciation of the Kwacha, increases in energy prices, imported inflation from South Africa, and increases in maize prices (supply constraints). Overall inflation exhibits persistence and seasonality. Further, the two sub-components of inflation display different characteristic behavior. This underscores the importance of employing a disaggregated approach in modelling inflation to improve information content and policy response. Three policy lessons can be drawn from these empirical results. Firstly, the dominant influence of the exchange rate on overall inflation and its sub-components requires a firm policy strategy to maintain stability in the exchange rate. Secondly, expanding and diversifying the manufacturing base to limit the current high dependence on imports of final consumer and capital goods from South Africa should be prioritised. Finally, the role of supply shocks—evident in the impact of maize prices on inflation—necessitates immediate significant reforms in the agriculture sector to boost productivity through the use of modern techniques such as irrigation in order to reduce dependence on rain fed practices.
Poverty in Togo between 2006 and 2011: Accounting for Differences in Poverty Rates and the Role of Economic Growth
(African Economic Research Consortium, 2022-06) Yao Nukunu, Golo
As is the case of other countries, Togo committed itself, at the Millennium Summit, to halving poverty rates by 2015. Despite the efforts Togo has made to this end, poverty levels remain high in the country as evidenced by the high poverty rate of 57.8% in 2011. This slow pace in poverty reduction raises the issue of how well the poverty phenomenon is understood in Togo. To contribute to a better understanding of the situation, this study sought to explain the strong disparities that exist between rural and urban areas and shed light on the contribution of economic growth and income redistribution to the poverty phenomenon. The study uses data obtained from the surveys conducted in Togo in 2006 and 2011 using the Questionnaire on the Basic Indicators of Well-being (Questionnaire Unifié des Indicateurs de Base du Bien-être, QUIBB). It followed the methodological approach used by Shorrocks (1999) to analyse economic growth and income redistribution, and that used by Blinder-Oaxaca (1973) to account for the differences in poverty rates between rural and urban areas. The study analyses growth and redistribution between the two reference years, and shows that strong economic growth is needed for any significant reduction in poverty to occur. However, growth has to be complemented with pro-poor redistribution policies. The poverty differences observed between Togo’s rural and urban areas are accounted for by disparities in the resources available for the two areas. This suggests that, since they are essential for poverty reduction, government interventions aimed at increasing the quantity of such resources in the rural areas should be given greater priority than those aimed at improving their quality.
Water Use and Agricultural Productivity Growth in Sub-Saharan Africa
(African Economic Research Consortium, 2023-08) Yannick, Djoumessi Fosso; Bergaly, Kamdem Cyrille Bergaly
Today, we are confronted with one of the greatest challenges of the 21st century: meeting the increasing needs of the population while reducing the damage caused by agriculture to the natural resources, namely water and land. Water is a complex resource, unlike a stable resource over human lifetime, such as land. To date, the empirical literature on the estimation of productivity in agriculture has disregarded water as an input. Given that it constitutes a necessary input, then its efficient use becomes a prerequisite condition. The main objective of this study was to investigate productivity growth in agriculture in sub-Saharan Africa, taking into account water as an input. The true-random Stochastic Production Frontier (SPF) was used to estimate the agricultural production function incorporating water as an input and to derive the total factor productivity (TFP) using a sample of 19 countries for the period 1991–2014. The results of the SFA model showed that the classical coefficients of the production function, including water endowment as an input, have a significant and positive impact on agricultural production growth after correction for the potential endogeneity bias. The average growth rate of TFP taking into account water as an input was estimated at 0.045% per year for the full sample period, a figure considerably lower than classical TFP estimated at an average rate of 1% per year. For the period 1991–2001, the rate was negative and estimated at -0.44% and 0.36% for the period 2002–2012. The higher performance in 2002–2012 may be due to the significant adoption of good agricultural practices along with technological advances that allowed for saving water (between -0.08% and -0.05% on average per year). Therefore it would be advisable to focus more on good practices in water saving, which are key to efficient use of water in agriculture.

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