ESTIMATING EFFECTIVENESS OF MONETARY POLICY IN ZAMBIA USING MONETARY RESPONSE FUNCTIONS.
University Of Bostwana
This study reviewed the effectiveness of monetary policy in Zambia using monetary response functions. The Zambian monetary policy has consisted of monetary aggregates as policy instrument from 1992 to 2012 and policy rate from 2012 to present. Effectiveness of the monetary policy was therefore estimated by running two monetary response functions, each based on one of the policy instruments. The effectiveness was determined by the policy instrument that is more responsive to macroeconomic changes. A VAR model was employed to estimate both monetary response functions using quarterly data for the period 2000 to 2016. The conclusions are based solely on the impulse response functions and the variance decomposition functions as it provides a standard deviation of the impacts of the macroeconomic variables on the monetary policy instruments. The results indicate that the policy rate responds positively to inflation gap, output gap, exchange rates and the lagged policy rate. This is in line with Taylor’s rule and shows the Central Bank systematic behaviour in monetary policy. The policy rate is seen to be biased towards output stabilization. The other response functions show that money supply responds negatively to inflation gap, output gap, exchange rates and lagged money supply. The money supply is biased towards inflation gap. The exchange rate is also observed to greatly impact money supply as an intermediate instrument. Based on this, we conclude that money supply is more effective in stabilising price, which is the main objective of monetary policy. Exchange rates aid in stabilizing price making the money supply instrument more effective than interest rate.