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October, 2006
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COMMON MARKET FOR EASTERN
AND SOUTHERN AFRICA
Seminar on Transmission Mechanism of Monetary Policy
Lusaka, Zambia
9 – 11 October 2006
REPORT OF THE SEMINAR ON THE TRANSMISSION
MECHANISM OF MONETARY POLICY
06 (cm)
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INTRODUCTION
1.
The Ninth Meeting of the COMESA Committee of Governors of Central Banks
which was held in November, 2004 in Lusaka, Zambia, decided that COMESA
should organise seminars on monetary policy, in order to enable member countries
to implement appropriate monetary policy mix that minimises interest rate and
exchange rates volatilities and contribute to economic growth and development.
2. In compliance with this decision, the COMESA Secretariat organised a seminar on
monetary policy from October 10 to 14 2005 in Swaziland, under the theme of “The
Conduct of Monetary Policy for Economic Development and Integration.”
3. The 10th Meeting of the COMESA Committee of Governors of Central Banks
which was held in November, 2005 in Bujumbura, Burundi, decided that a seminar
on the transmission mechanism of monetary policy be held in 2006, in order to
enable member countries to share experiences. Based on the decision, this Seminar
was held from October 9 to 11, 2006, in Lusaka, Zambia.
A. ATTENDANCE, OPENING OF THE MEETING, ADOPTION OF THE AGENDA
AND ORGANISATION OF WORK
4.
The meeting was attended by officials from the Central Bank of Burundi,
Central Bank of Egypt, Central Bank of Kenya, Reserve Bank of Malawi, Bank of
Mauritius, Central Bank of Madagascar, National Bank of Rwanda, Bank of Sudan,
Bank of Uganda, Bank of Zambia and Ministry of Economic Development of
Zimbabwe. (The list of participants is in annex I)
Opening of the Meeting (Agenda item 1)
5.
Dr. Charles L. Chanthunya, Director of Trade, Customs and Monetary Affairs
made a statement on behalf of Mr. Erastus J.O. Mwencha, the Secretary General of
COMESA. In his statement, he stressed the importance of creating wealth that is
based on structural transformation and economic diversification, savings and
investment growth, export growth and conversion of comparative advantage into
knowledge based competitive advantage. He stated that one of the policy
instruments needed to support structural transformation of the economies of
COMESA member countries, is monetary policy. He said that, the basic goals of
monetary policy in the statutes of most central banks is to promote price stability in
support of sustainable economic growth and employment.
6.
He pointed out that, even though monetary policy cannot affect either output
or employment in the long run, it can affect them in the short run. He, therefore,
underscored the fact that, it is necessary to understand the channels of the
transmission mechanism of monetary policy. He said, distinguishing the relative
importance of various channels of monetary transmission is useful for the following
reasons: First, understanding which financial aggregates are impacted by policy
would improve the understanding of the links between the financial and real sectors
of the economy. Second, a better understanding of the transmission mechanism
would help policy makers interpret movements in financial aggregates more
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precisely. Finally, more information about the transmission mechanism might lead to
a better choice of targets.
Adoption of the Agenda and Organisation of Work (agenda Item 2)
7.
The meeting adopted the following agenda:
1. Opening of the Meeting
2. Adoption of the Agenda and Organisation of Work
3. Transmission Mechanism of Monetary Policy-Conceptual Framework
4. Experience of Transmission Mechanism of Monetary Policy in:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
Kenya
Egypt
Zambia
Mauritius
Malawi
Madagascar
5. Monetary Policy Transmission Mechanism in Emerging Economies
6. Monetary Policy Transmission Mechanism: Operating and Intermediate
Targets
7. Any Other Business
8. Adoption of the Report and Closure of the meeting.
8.
The meeting agreed on the following hours of work:
Morning
Afternoon
09:00 – 13.00 hours
14.30 -17.00 hours
B. ACCOUNT OF PROCEEDINGS
Transmission Mechanism of Monetary Policy-Conceptual Framework (agenda
item No. 3)
9.
Mr. Zeidy of the COMESA Secretariat, made a presentation under this
agenda item. In his presentation he highlighted the following points:
 In conducting monetary policy, most central banks have the goal of price
stability in support of stable economic growth. In trying to reach this goal, the
central bank use monetary policy instruments, among others, reserve
requirements, discount rate, and open market operations.
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 Because there are several steps between monetary policy instruments and
the ultimate behavior of prices and economic activity and because these steps
often can’t be predicted accurately, central banks use intermediate targets
called indicators. The most frequently used intermediate targets are: money
supply, and interest rates.
 The main channels of monetary transmission mechanism include: interest
rate channel, exchange rate channel, other asset prices effect and the money
and credit channel
10.
He then elaborated on how monetary policy is transmitted through each
channel as follows:
The interest Rate Channel
 Tight monetary policy for example through an increase in discount rate makes
borrowing through the discount window more costly.
 If banks reduce their borrowing in response to a higher discount rate, the
monetary base falls.
 The decrease in monetary base leads to a reduction in money supply. This
leads to a general rise in interest rates.
 This leads to reduction in aggregate demand, via reduced investment and
consumption expenditure
The Credit Channel
 A tightening of monetary policy reduces bank reserves. With fewer deposits
on hand, banks have a smaller quantity of funds available to lend. As banks
cut back their lending, borrowers who depend on bank for credit are unable to
obtain credit they need to make planned purchases. The resulting decline in
spending depresses aggregate demand and thus economic activity.
 On the demand side of the credit market, tight monetary policy has the effect
of making potential borrowers less eligible for loans or less eligible for loans.
E.g. a firm that has a substantial amount of floating rate debt. If tightening of
monetary policy raises interest rates, the firm’s interest rate costs will rise,
reducing its profitability. The firm’s reduced profitability makes lending to the
firm riskier, so the firm will have problem of obtaining credit.
 Alternatively, a consumer who wants to use some shares of stock that he
owns as collateral for bank loans. Tight monetary policy reduces the value of
those shares (as financial investors, lured by higher interest rates, switch from
stocks to bonds). With reduced collateral, the consumer will be able to borrow
less. The reduction in credit available to the borrower is likely to lead to
reduced spending and thus a weaker economy.
Exchange Rate Channel
 Tightening of monetary policy strengthens the real exchange rate. A stronger
real exchange rate, by making domestic goods more expensive for foreigners
and foreign goods cheaper for domestic residents, reduces the demand for
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the home country’s net exports. All else being equal, this reduced demand for
net exports reduces aggregate demand, depressing output and prices.
11.
He also discussed how the impacts of a change in monetary policy instrument
(e.g. the short term interest rate or base money) on intermediate variables (such as
broad money or domestic credit) and final objectives (output and inflation) are
examined by using VARs (Vector Autoregressive Model).
12.
He highlighted the following challenges for Transmission Mechanism of
Monetary Policy in developing economies:
 The effectiveness of monetary policy guided by quantitative targets depends
not only on the stability of the demand for money function, but also on the
closeness of the relationship between monetary aggregates and ultimate
target of inflation.
 In a rapidly changing environment it is indeed very difficult to identify with
precision the channels through which monetary policy affects the economy.
The remarkable development of the financial system in recent years has
provided the business community with a much wider array of financing
alternatives. Business community in many countries are now able to avail
themselves of a great diversity of products offered by finance companies and
other non-bank financial institutions which have experienced very rapid
growth in recent years. The growing trend of securitisation has also led to a
greater marketability and liquidity of every type of economic activity or
transaction.
Country Experiences on Transmission Mechanism of Monetary Policy (Agenda
item No. 4)
(i) Kenya
13.
Dr. Benjamin O. Maturu discussed the evidence on monetary policy
transmission mechanism in Kenya. He observed that apart from identifying excess
money supply as the main cause of inflation, there is need to understand the nature
of the causal relationship between money and inflation. The basic question therefore
is: how does money influence inflation? More specifically, one needs to answer the
following questions.
1. By how much does inflation fall following a specified amount of reduction
in money supply?
2. Does the influence of a change in money supply/policy rate on inflation
occur immediately or gradually?
3. Is the influence of a change in money supply/policy rate on inflation
temporary or permanent?
4. What is the sequence of events starting with a change in the value of the
monetary policy-operating instrument to a change in inflation?
5. Alternatively, what are the channels of monetary policy transmission
mechanism?
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14.
He informed the meeting that while evidence continued to increase, the study
findings on transmission mechanism are not amenable to generalized application
across countries because of varied socio-economic structures among countries. With
rapid socio-economic transformation, especially in the financial sector, even countryspecific evidence is quickly rendered obsolete. The best way forward, therefore, is to
carry out studies on monetary policy transmission mechanism within each country for
more specific and relevant results. These results should however be reviewed
regularly to keep pace with socio-economic transformations. Consistently, the
Central Bank of Kenya has been studying monetary policy transmission mechanism
in Kenya leading to the preliminary results shared at the seminar.
15.
He informed the meeting that, the conduct of monetary policy in Kenya is
within the context of a monetary targeting policy operating framework. Reserve
money is the operating target, money supply, the intermediate target and inflation the
ultimate target. He observed that under this framework, it is expected that changes in
reserve money are fully and quickly reflected in corresponding changes in money
supply. Similarly, the policy-induced changes in money supply are expected to fully
and quickly influence inflation. Thus, a change in reserve money causes a liquidity
effect that induces the cost-of-capital effect that in turn influences demand, supply
and then inflation. The effect on inflation arising from a change in money supply
need not necessarily be direct.
16.
He informed the seminar participants that the evidence on transmission
mechanism of monetary policy in Kenya is derived using vector autoregressive
analysis and simulations carried out on the Bank’s macroeconomic model. The
Structural VAR model results show that the traditional money channel is not
operational since the liquidity effect is insignificant, thereby, precluding the existence
of the cost-of-capital effect. Besides, only 40% of the policy signal released as a
shock to reserve money is delivered to broad money supply that is the intermediate
target while only 43% of the policy signal released as a shock to broad money supply
is directly delivered on overall inflation.
17.
In contrast, the repo rate significantly influences inflation, at the very earliest,
in the 5th month while the largest significant impact occurs in the 13th through the 18th
month. Accordingly, the implied monetary policy transmission lag in Kenya is 13 to
18 months which compare well with the results derived from simulations using the
Central Bank Macroeconomic model whereby the peak impact of monetary policy
change on inflation occurs in the 19-20 months.
18.
The vector auto-regressive and macroeconomic model simulation results
show that the exchange rate responds to monetary policy changes in a theoretically
consistent manner whereby monetary tightening leads to an appreciation of
exchange rate and a reduction in inflation.
19.
Dr Maturu further, argued that while the vector auto-regressive results do not
cover analysis of the operational status of the expectations channel, indications are
that the expectations channel operates, too. He cited Maturu, Kethi and Maana
(2006) that fits Kenyan data to the New Keynesian Phillips Curve model of the
inflationary process to establish that 60% of the firms that adjust their prices exercise
a forward-looking expectation scheme while only 40% are backward-looking.
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Moreover, preliminary work on Central Bank credibility show that the credibility
parameter estimate is significant. These results imply that economic agents including
consumers and investors anchor their expectations about inflation on the inflation
target pursued by the Bank as a sufficiently good indicator of future inflation.
Consistently, the agents are responsive to monetary policy changes and the
expectations channel of monetary policy transmission is operational.
20.
Dr. Maturu concluded that the interest rate and the exchange rate channels of
monetary policy transmission are the most effective. These channels are re-enforced
by the bank-lending channel. The traditional money channel is not operational since
the liquidity effect is insignificant thereby precluding transmission to the cost-ofcapital that would have in turn induced a change in aggregate demand and
inflationary pressures. There are indications also that the expectations channel is
operational in Kenya.
21.
The policy implication of the results is that an interest rate monetary policyoperating framework would be more effective in transmission of monetary policy. Ongoing research on monetary policy transmission mechanism and building a
macroeconomic model for policy analysis and forecasting are good steps towards
adoption of a policy framework based on an interest rate operating framework.
(ii) Egypt
22.
Mrs. Samia Torky of Central Bank of Egypt presented a paper on the
experiences of the Central Bank of Egypt on implementation and transmission
mechanism of monetary policy. She informed the seminar participants, the following
on the experiences of the Central Bank of Egypt in implementation of monetary
policy:
(a) Institutional Features

The Central Bank of Egypt (CBE) is no longer under the supervision of
any government Ministry, but it directly reports to the President, which
enabled CBE to be more independent.

By the new Law issued in 2003, the CBE is responsible for design and
implementation of monetary policy. The Law also states that the
ultimate target for monetary policy is price stability. The government
announced its intention to apply inflation targeting, when fulfilling the
prerequisites.

The co-coordinating Council has been established in 2005, chaired by
the Prime Minister. The members include: some experts who have
experience in international organizations. The Council is responsible to
coordinate the fiscal and monetary policies.

The Monetary Policy Committee (MPC) has been established with in
the members of the Board of Directors of CBE, chaired by the
Governor. The MPC meets according to a pre-announced schedule. It
makes decisions on the policy rates and communicates immediately
after each meeting to the market.
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
The Monetary Policy Unit (MPU) has been separated and is under the
supervision of the Deputy Governor and is supported by high officials.
(b) The Operational Framework
The operational framework applied by CBE since June 2005 includes the following:
 The operational target for CBE is the overnight inter-bank rate.
 The set of instruments used are the following:
(1)
Open Market Operations (OMO) are the main operations carried out on
a weekly basis. Long term operations are carried out once a month for three
months. Fine tuning operations are carried out to cover the liquidity shocks and
forecasting errors.
(2)
Reserve requirements: This is 14% of total deposits after excluding the
savings certificates, which mature in three years and more. The maintenance
period is two weeks and the averaging mechanism is used..
(3)
Standing facilities: These are overnight deposit facility and overnight
lending facility.

The instruments are used using the corridor system with two overnight
facilities. The deposit rate represents the floor of the corridor rates and
the lending rate is it’s upper boundary.

The benefits of the new framework are steering the short term interest
rates, lowers volatility in interest rates and excess liquidity, in addition
to increasing the volume of interbank activities.
(4)
Liquidity forecasting is a very important element in conducting
monetary policy.
(5)
Communication and transparency are also very important elements in
conducting monetary policy.
23. Mrs. Torky informed the participants that the transmission of monetary policy in
Egypt is affected by the level of development of the money market, the liquidity
position of banks and government operations.
(iii) Zambia
24. Dr. Noah Mutoti of Bank of Zambia presented a paper on the transmission of
monetary policy in post-liberalized Zambia, corresponding to monetary targeting. He
informed the meeting that, in developing countries, especially Sub-Saharan very little
is known about issues central to underlying monetary policy. In particular, how the
economy responds to shocks, the relative importance of various transmission
channels, the magnitude and timing of monetary policy effects and the effectiveness
of various policy instruments are less understood. Recently, however, with the
deregulation of financial markets and monetary policy becoming more oriented
towards market-based operations, there has been increased interest in
understanding the working of such economies. Contributing to this growing literature,
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his article examines the transmission of monetary policy in post-liberalized Zambia,
focusing on the role of money and exchange rate.
25.
He informed the meeting that, facing rising inflation in early 1990s, as part of
International Monetary Fund (IMF) /World Bank-supported reforms, Zambia adopted
monetary targets as a guide to monetary policy. During the early years of this
regime, inflation abated and declined to unprecedented levels not seen in more than
two decades. Annualized consumer price (CPI) inflation, consistently in 3 digits in the
last half of 1980s, broke at the end of 1994, falling sharply to about 54 % and
subsequently to below 20 % at end1997. With CPI inflation stuck within the 17–30%
range between 1998 and 2005, the disinflation process seemed to have stalled.
Recently, CPI inflation has assumed a remarkable downward trend, declining to
single digit, 9.4%, in April 2006 for the first time in 30 years. At the end of the first
half of 2006, it declined further to 8.5% and three months later to 8.2%. He stated,
therefore, that the question of the effects of money-supply and money-demand
shocks in consumer price formation is highly relevant. With the advent of flexible
exchange rates, the role of exchange rate shocks in output and inflation dynamics is
also of great empirical interest, especially that the exchange rate has been quite
volatile. As effective monetary policy implementation requires, inter alia, the
monetary authority developing a reasonably clear view of the major shocks that
influence the economy, an investigation of how the domestic economy responds to
aggregate supply, IS and foreign shocks is also deemed vital. He explained that
these questions were addressed by means of a structural vector error correction
model (SVECM).
26.
In his study, he concluded that the impact of money supply shocks on
Zambia’s output is little and temporary. Output volatility is mainly associated with
aggregate supply and IS shocks, the latter more pronounced in the short run. Money
supply shocks also hardly explain Zambia’s consumer price inflation. Further, though
the money demand is relatively stable, the role of money-demand shocks in
consumer price developments is only pronounced in the short run. What underlay
most consumer price movements are aggregate supply and exchange rate shocks.
With monetary policy found to have generally served to dampen inflationary
pressures induced by exchange rate shocks, support is given to exchange rate as a
plausible channel of transmission.
27.
He drew policy implications from two key observations. First, though a positive
monetary policy shock leads to a sharp and persistent rise in money supply, a strong
consumer price response is only recorded in the initial period. Second, money
demand is stable and yet the role of money demand shocks in consumer price is
only pronounced in the short run. These suggest a weakened link between money
and inflation, giving rise to situations where getting the monetary target does not
produce the desired inflation outcome and where money fails to produce reliable
signals of the stance of monetary policy. Since food price has the largest share in
CPI and the dominant role of exchange rate in inflation dynamics established,
sustaining lower inflation in Zambia requires policies meant at boosting domestic
food supply and stabilizing exchange rate.
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(iv) Mauritius
28.
Mr. Bissessur of Bank of Mauritius highlighted the transmission mechanism of
monetary policy in Mauritius. He elaborated on the monetary policy implementation
that was pursued by Bank of Mauritius in the last two decades. He added that
according to the Bank of Mauritius Act 2004, the primary objectives of the Bank of
Mauritius are to maintain price stability and to promote orderly and balanced
economic growth. The Bank is also required to regulate credit and currency in the
best interests of the economic development of Mauritius and to ensure the stability
and soundness of the financial system of Mauritius.
29.
Regarding the transmission channels of monetary policy, he noted the
following :
(a)
Exchange Rate Channel

(b)
Inflation in Mauritius is determined by both domestic and external factors.
When the Bank of Mauritius changes the Lombard Rate, exchange rates are
also affected. However, the impact of monetary policy on exchange rate did
not provide conclusive results. Nonetheless, the exchange rate channel must
operate in Mauritius, especially as Mauritius is a small open economy. The
pass-through from exchange rate changes to consumer prices is estimated at
around 0.4. That is, a one per cent change in the exchange rate brings about
a 0.4 per cent change in the rate of inflation.
Interest rate channel

.When the Bank changes the Lombard Rate, which is the rate that is used to
signal the monetary policy stance, banks’ lending and deposit rates are
affected, with banks adjusting their prime lending rate and savings deposit
rate accordingly. Since lending rates and term deposit rates are linked to the
prime lending rate and savings deposit rate, they are also affected
accordingly. Then, short-term interest rates and other interest rates in the
economy are affected. The exchange rate of the rupee is also influenced
following the change in the Lombard Rate. Interest rates and exchange rates
affect aggregate economic activities (aggregate demand and supply), and
finally, the changes in aggregate demand and supply affect inflation. The
efficacy of the mechanism depends largely on the Bank’s ability to control the
liquidity position of the banking sector. The liquidity forecasting exercise
involves estimating the next day’s liquidity position of the banking sector and
also, the weekly average level of liquidity in the banking system based on the
maintenance week for the cash reserve ratio. Based on this information, the
Bank decides on the level of intervention that is needed to inject more
liquidity or remove liquidity from the market. The intervention is conducted
through open market operations.

Changes in lending rates affect the cost of capital in the economy and have
an impact on cash flow, thereby affecting the propensity to save. A welldeveloped financial market is essential to ensure the transmission of policy at
this stage. Interest rates and exchange rate are also affected by factors other
than the very short-term interest rates. In particular, government budgetary
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considerations and the underdevelopment of financial markets have a
significant influence on other interest rates, while the international economic
environment affects the exchange rate.

He stated that the transmission of changes in interest rates and the exchange
rate to aggregate demand and supply takes place through changes in the
cost of capital, changes in inter-temporal substitution, and wealth effects. The
cost of capital affects the purchases of durable goods, investment in housing,
business investment in plant and equipment, and inventory holdings. A rise in
interest rates reduces the present value of any expected income stream and
tends to lower present consumption. Changes in the exchange rate affect the
price of goods, thus affecting the supply and demand. A rise in the real
exchange rate shifts demand from local goods to imports thus affecting the
aggregate demand.

Following a change in interest rates, the wealth effect and substitution effect
change current expenditure on consumption. For instance, for a lender, the
fall in interest rate will lower his interest income, thereby adding an income
effect on current consumption. On the supply side, since firms usually finance
most of their working capital through loans, higher interest rates will affect
their activities through the cost of funds. Changes in the exchange rate affect
aggregate supply through changes in competitiveness. In the final stage of
the mechanism, changes in aggregate demand affect inflation and expected
inflation, through increasing or decreasing the slack in demand in relation to
long run output level.
c) Bank Portfolio Channel
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30.
(v)
Mr. Bissessur made the following conclusions
(i)
To successfully conduct monetary policy, the central bank needs to have a
good assessment of the timing and magnitude of the impact of the policies
on the economy. Consequently, an understanding of the channels of
transmission mechanism is vital.
(ii)
A good payment system as well as sound banking sector are essential for
the transmission mechanism to work.
(iii)
The monetary transmission mechanism in Mauritius is about to undergo
some significant changes as the Bank is moving away from targeting
reserve money towards targeting the overnight interbank interest rate. A
new monetary policy framework is in process. A key Repo rate will be
used to signal the monetary policy stance of the Bank, instead of the
Lombard Rate, as has been the case hitherto. With banks used to moving
interest rates in accordance with changes in the Lombard Rate, the
monetary transmission mechanism is expected to operate through the
interest rate channel. This is because the key Repo rate, as the price of a
significant source of funds to banks than was the Lombard Rate, will be
much more closely connected to other short-term market interest rates.
(iv)
Nonetheless, because the supply of reserve money will be varied as
required to keep the overnight interbank rate near the key Repo rate, the
money channel should continue to be important. Moreover, Mauritius
being a small open economy, the exchange rate channel is also expected
to prevail.
Malawi
31.
Mr Milner of the Reserve Bank of Malawi presented a paper on Monetary
Policy and Transmission Mechanism in Malawi. He highlighted the following:
(a)
Monetary Policy in Malawi
 Until the late 1980s, Malawi’s monetary policy regime was
characterized by extensive controls, ranging from direct credit and
interest rate ceilings to controls on foreign exchange allocation

From 1987 into the 1990s, Malawi embarked on policy reforms that
led to the replacement of most of the controls with indirect, marketoriented instruments

The reforms eased entry of banks into the market and, therefore,
ushered in new financial institutions

The banking supervision function was moved to the central bank
and was enhanced to include prudential issues

Malawi started practicing a more active monetary policy in pursuit of
the price stability objective

Currently Malawi is pursuing a monetary targeting regime, under
which the broad money stock (M2) is the nominal anchor while net
domestic assets (NDA) of the monetary authorities is the operating
target
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Page 13

(b)
A Monetary Policy Committee was instituted in February 2000 in
order to enhance efficiency and transparency in the formulation and
conduct of monetary policy
Monetary Policy Transmission in Malawi
 Little analytical work has been done on monetary transmission
mechanism in Malawi. However, results from a VAR-based analysis
that was presented indicated that:
- the exchange rate is the most important channel of transmission
- the interest rate channel is not that important
- results for the money and credit channel are inconclusive
32.
He therefore outlined the following major challenges for the study of the
monetary transmission mechanism in Malawi:
(a)
A low level of monetization of the economy, which is associated with
the existence of parallel credit and foreign exchange markets. Thus,
modeling the transmission mechanism in the traditional way would only
produce spurious results. It is therefore necessary to incorporate these
parallel structures in the transmission mechanism model;
(b)
Domestic demand is insensitive to interest rate changes. While it is
important to model this, disaggregated data to enable analysis of
various demand components does not exist;
(c)
Future work on the monetary mechanism in Malawi should take into
account the fact that the exchange rate has become a major influence
on economic activity and inflation in recent times;
(d)
The low level of competition in the banking industry is a constraint on
the effectiveness of the credit channel; and
(e)
The envisaged monetary union will, among other things, entail loss of
independent monetary policy for member countries and the resultant
reduction/amelioration in importance of some transmission channels. In
that regard, the following issues have to be considered:
 the likely impact of such dynamics on the effective operation of
monetary policy;

implication of differences in transmission mechanisms among
member countries; and

appropriateness of monetary policy against a background of
differences in the speed of adjustments owing to diverse conditions
in different countries.
33.
He concluded by stating that a lot of work needs to be done to unravel the
monetary transmission mechanism in Malawi to better inform policy makers on the
timing and effects of monetary policy. The econometric study that was undertaken
points to a weak transmission mechanism. In order to come up with better
coefficients, the above-mentioned challenges have to be addressed. Studying the
monetary transmission is a data intensive exercise and calls for concerted efforts to
gather that information.
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(vi)
Madagascar
34.
Mr. RAZAKAMANANTSOA of Central Bank of Madagascar presented the
operation and transmission of monetary policy in Madagascar. He highlighted the
following to the seminar participants:
 Interest rate channel is inefficient. Deposits rate are very low even though
central bank rate significantly increases
 Lending rate automatically adjusts when Central Bank raises its rate. Most
loans are however, concluded with a fixed interest rate.
 The amount of the credit (in real terms) did not decrease significantly after the
Central Bank discount rate had risen.
 The Treasury bill rate seems to be used as a reference rate instead of the
central bank discount rate.
 The interest rate channel is inefficient because of the importance of the fixed
rate on loans and lack of competitiveness of the banking system,
 The high level of Treasury bill rate weakens liquidity operations which are
made to avoid sudden devaluation of local currency.
 In order to improve the transmission mechanism of monetary policy the
following policies were recommended:
-
Improve competitiveness of the banking ;
-
Decrease short term Treasury bill rates step by step.
-
The Central Bank should not only pay attention to inflation and
devaluation but also to production.
Transmission of Monetary Policy in Emerging Economies (agenda item 5)
35.
Dr. Noah Mutoti of Bank of Zambia presented a paper on the Transmission
Mechanism of Monetary Policies in Emerging economies, written by Steven Kamin,
Philip Turner, and Jozef Van’t dack .
36. He informed the meeting that there are two important aspects that have to be
considered in evaluating how fast monetary policy affects the real economy. The first
is the transmission from instruments directly under the central bank’s control, e.g.
short-term interest rates or reserve requirements to those variables that most directly
affect conditions in the non-financial sector- loan rates, deposit rates, asset prices
and the exchange rates. This linkage is determined primarily by the structure of the
financial system. The second aspect is the link between financial conditions and the
spending decisions of households and firms. In this regard, the initial financial
position of households, firms and banks is likely to play a key role, including the
extent of leveraging, the composition and currency denomination of assets and
liabilities, and the degree of dependence upon external financial resources, in
particular bank financing.
37.
He stated that both aspects of the monetary transmission channel are likely to
have been affected by the process of financial liberalization in many countries in the
past decade. The reduced role of the government in the financial system has
lessened the importance of the credit availability channel compared with the interest
CS/TCM/SEMINAR/TMMP/I/8
Page 15
rate channel. The increased fragility of the financial sector in the wake of financial
liberalization may have accentuated other aspects of the credit channel. At the same
time, the opening and deepening of financial systems in emerging market countries
has caused both the assets and the liabilities side of the private non-financial
sector’s balance sheet to become more diversified, there by enhancing the role of
asset prices, in particular the exchange rate, in the monetary transmission process.
38.
He then outlined the four important aspects of the monetary transmission
process where uncertainties and/or disagreement are especially deep, namely: (i)
the transmission of monetary policy actions to long term interest rates and asset
prices; (ii) gauging the tightness of monetary conditions, (iii) The scope for monetary
policy under fixed exchange rates and financial fragility, and (iv) the effects of
monetary policy in high inflation economies. In all cases, the state of expectations
very largely conditions the impact of monetary policy, and it is this which gives rise to
the uncertainties.
39. He proposed that there is need to undertake research on the following
unexplored topics.
1. The conduct and transmission of monetary policy in a partially dollarised
financial system;
2. Sectoral response of demand to monetary policy shocks in developing
countries.
Monetary Policy Transmission Mechanism: Operating and Intermediate
Targets (agenda item No. 6)
40.
Dr. Michael Antigi-Ego of Bank of Uganda made a presentation under this
agenda item. He highlighted the following to the seminar participants:


In the long run, monetary policy has no effect on output. In the short run
monetary policy has real effects on output and employment
The pursuit of final goals of monetary policy rests on a series of choices or
strategy, which in turn depends on:
 The structure of the economy and financial markets
 Information set used as a basis for short term and long term policy
adjustments; and
 Weights and specific roles attached to various economic variables.

World over, price stability is a core objective in most central banks.

Deep and well functioning financial markets affect the speed and impact of
monetary policy on aggregate demand, output and eventually inflation in
the economy. Well functioning financial system, therefore, are important
CS/TCM/SEMINAR/TMMP/I/8
Page 16
for implementation of monetary policy, thus, financial sector stability as
well concerns central banks
.

But implementation of monetary policy would also influence financial
markets in other ways – the reason why central banks have remained
major stakeholders in ensuring financial stability.
41.
He explained that an increase in Policy/official interest rates is more effective
in reducing inflation where:
 The broader interest rate spectrum and exchange rate is sensitive to
the changes in policy/official rates
 Residents’ demand for domestic net liabilities and foreign demand for
domestic assets are sensitive to changes in interest rates;
 Financial liabilities are large relative to GDP; and
 The country’s net financial liabilities increase
42.
He underscored that the effects of monetary policy will be much greater in an
economy where there is macroeconomic stability, and credibility and consistency in
monetary policy. Monetary policy commitment to macroeconomic stability is key in
influencing expectations of economic agents, hence their savings and investment
decisions, thus AD and inflationary expectations.
43.
He
pointed out that the
exogenous shocks namely, fiscal shocks,
developments in global economy, commodity prices, and weather complicate the
transmission mechanism of monetary policy: Changes in an economy, say through
economic liberalization, financial sector reforms; have had implications for the
transmission of monetary policy. This calls for continuous study of how monetary
shocks are transmitted into prices. However, precise impact of monetary policy on
expectations is difficult to ascertain and probably varies from time to time.
44.
Dr. Antigi-Ego also explained that transmission of monetary policy in
developing countries like COMESA region would be characterized with lags and
uncertainties as to which avenue has been utilized. Hence, strategic issues for
monetary authorities to facilitate implementation of monetary policy include: choice of
operational target, intermediate targets and indicators. He stated that operational
target should share a close and predicable relationship with the intermediate target.
Common examples are: base money, reserves and short term interest rates. In the
COMESA region, base money is most commonly used as operating target. He
emphasized that the intermediate variable should have a close and predictable
underlying relationship with inflation, the final goal. Where monetary aggregates are
used as an intermediate targets there should be a stable money demand function. At
best, monetary policy must be able to guide the intermediate variable towards its
target
45.
He further explained that the choice of intermediate target is the determinant
of the monetary policy regime or framework for implementation of monetary policy.
He stated that, historically monetary frameworks have been identified along the lines
of: Monetary, Exchange rate, Interest rate, and Inflation targeting regimes. The most
common framework of monetary policy is the monetary targeting framework in the
COMESA region.
CS/TCM/SEMINAR/TMMP/I/8
Page 17
46.
He recommended the following policy actions to improve the conduct of
monetary policy in the region:
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.
x.
xi.
xii.
Institutional and Structural Reforms in the Financial Sector;
Examination of Money Multipliers and Income Velocity of Money in the
COMESA member countries;
commitment to avoiding excessive money creation, including for the
financing of fiscal deficits;
a high degree of political and instrument independence of central
banks during the move toward monetary union, and for the common
central bank thereafter.
an improvement in financial sector soundness by strengthening and
harmonising prudential regulation and supervision, reduce nonperforming loans, improve and harmonize the legal and judicial
environment, allow cross-border flows of funds within the region,
Put in place the necessary indirect instruments of monetary policy for
effectively influencing market-determined interest rates in the region.
Harmonize exchange arrangements vis third countries, including the
existing regimes of regulatory controls for external capital transactions
with countries outside the region.
Increased capital account convertibility should be preceded by
adequate progress in strengthening and harmonizing prudential
regulations and supervision practices in the financial sectors.
Prevent costly government bailouts of banks,
reduce the high interest rates and spreads between the lending and
deposit rates of banks,
enhance the transmission of monetary policy effects, improve the
prospects for regional capital mobility and intermediation,
narrow the cross-country differentials in interest rates within the region.
47.
He also recommended that the following policy measures should be in place
during the transition period to monetary union in COMESA:







need to maintain interest rate flexibility;
promote greater stability in bilateral exchange rates,
credibility and confidence in the process leading to the eventual fixity of
these exchange rates.
The decline in inflation supported by substantial reductions in the rates of
growth of both reserve and broad money.
Future policies seeking to control inflation need to be coordinated based on
an understanding of its key determinants in each country, including
differences in money demand that affect the velocity of money, and in the
reserve money multiplier that affect supply
The design of policies in support of monetary stability, should closely follow
developments in the degree of monetization, a variable in which vary
considerably in the COMESA region.
public expenditure programs should aim at achieving the MDGs.
CS/TCM/SEMINAR/TMMP/I/8
Page 18


When the stage of Exchange rate union is reached the (supra)/central bank
needs to make various strategic decisions on how it is to proceed. Key
among these are: the instruments and operating target the intermediate
target variable and hence monetary policy regime.
Undertake studies to understand the transmission mechanism of monetary
policy. In the region.
Recommendations of the Seminar
48.
After an extensive discussions, the seminar agreed on the recommendations
which are in paragraphs 46 and 47.
49. The seminar recommended that a comparative study on transmission
mechanism of monetary policy in member States should be undertaken by the
COMESA Secretariat. The study should identify weaknesses, differences and
commonalities on the transmission process and make recommendations on how to
achieve efficient transmission of monetary policiy given the target of price stability in
each member country.
Any Other Business (Agenda item No. vii)
50.
No issues where raised under this agenda item.
Adoption of the Report and Closure of the Seminar (Agenda item No. viii)
51. The seminar adopted the report with amendments..
52. In closing the seminar, the Chairman thanked all delegates for their contributions.
He emphasized the importance of networking in order to learn lessons from each
other. He thanked COMESA Secretariat for organizing the seminar.
53. Dr. Charles L. Chanthunya, the Director of Trade, Customs and Monetary Affairs
in COMESA also thanked the delegates for having come to the seminar and for their
useful contribution. This he said, enabled participants to learn a lot of lessons from
each other. He also thanked the interpreters and the Mulungushi Conference
Centre. He wished all the delegates safe journey back home.
CS/TCM/SEMINAR/TMMP/I/8
Page 19
LIST OF PARTICIPANTS/LISTE DES PARTICIPANTS
BURUNDI
Nkusi Rose Kamariza, Board Advisor, Banque de la Republique du Burundi, P O
Box 705, Bujumbura; Tel: (257) 218244, Fax: (257) 223128; E-mail:
[email protected]
M. Augustin Riragendanwa, Responsable du services Caissier de l’Etat, Banque de
la République du Burundi, B. P. 705, Bunjumbura, Tel: (257) 225811/225142, Fax:
(257) 223128; E-mail: [email protected]
KENYA
Dr. Benjamini Ongwae Maturu, Assistant Director, Central Bank of Kenya (CBK),
P.O. Box 60000, Nairobi; Tel: (254-20) 251710/2863204, Fax: (254-20) 214982;
Email: [email protected]
EGYPT
Mrs. Samia Abd El-Wahab Ali Torky, Assistant Sub-Governor, Central Bank of
Egypt, 31. Kasr El-Nil Street, Downtown, Cairo, Tel: (202) 3911051/2012, 2675083,
Fax:
(202)
3922875;
E-mail:
[email protected]
or
[email protected]
MADAGASCAR
Ms. Razakamanantsoa Lalaniaina Mamisoa Christian, Attaché de Direction, Banqué
Centrale De Madagascar, B.P. 550, Antananarivo, Tel: (261) 202221751, Fax: (261)
202234532; E-mail: [email protected] or [email protected]
Noromahefa Lala Harifetra, attaché De Direction, Banqué Centrale De Madagascar,
B.P. 550, Antananarivo, Tel (261) 202221751, Tax: (261) 202234522; E-mail:
[email protected] or [email protected]
MALAWI
Mr. Joseph L. G. Milner, Manager, Middle Office, Treasury Dept, Reserve Bank of
Malawi, P.O. Box 30063, Lilongwe 3, Tel: (265-1) 770600, Fax: (265-1) 772752; Email: [email protected]
MAURITIU/SMAURICE
Mr. Jitendra Nathsingh Bissessur, Assistant Director, Research (Statistics), Bank of
Mauritius, 29 Sir William Newton Street, Port Louise, Tel: (230) 2023987, Fax: (230)
2084638; E-mail: [email protected]
CS/TCM/SEMINAR/TMMP/I/8
Page 20
Yandraduth Googoolye, First Deputy Governor, Bank of Mauritius, Sir William
Newton Street, Port Louis, Tel: (230) 2023962, Fax: (230) 2120313; E-mail:
[email protected]
RWANDA
Mr. Munyankindi Pascal, Head of Monetary Research, National Bank of Rwanda
(Central Bank), P.O. Box 531, Kigali, Tel: (250) 574282, Fax: (250) 572551; E-mail:
[email protected]
Kasangwa Chantal, chef de section “Interventions sur le Marche Monetaire”, Avenue
Paul VI, B.P. 531, Kigali, Tel: (250) 59142272/08504063, Fax: (250) 576197; E-mail:
[email protected]; [email protected]
SUNDAN/SOUDAN
Ms. Salaheldin Sheikh Khidir, Director, Central Bank of Sudan, P.O. Box 313,
Khartoum, Tel: (249) 183 781341/912985481, Fax: (249) 183 781341; E-mail:
[email protected]
Mr. Rehab El Sharief El Khatim Mohamed, Official Economist, Central Bank of
Sudan, P.O. Box 313, Khartoum, Tel: (249) 0912247037, Fax: (249) 183 781341; Email: [email protected]/ [email protected]
UGANDA/OUGANDA
Dr. Michael Atingi-Ego, Research Director, Bank of Uganda, 37/43 Kampala Road, P
O Box 7120, Kampala, Tel: 256 41 259866, Fax: 256 41 254760, E-mail:
[email protected]
ZAMBIA/ZAMBIE
Dr. Noah Mutoti, Acting Assistant Director, Macroeconomic Analysis Division, Economics
Department, Bank of Zambia, P O Box 30080, Lusaka, Tel: 260-1-228888, Fax: 260 -1221722, E-mail: [email protected]
Mr. Mulenga Musepa, Senior Economist, Bank of Zambia, P.O. Box 30080, Lusaka,
Tel: 228888, Fax: 221721; E-mail: [email protected]
Mr. Jacob Lungu, Economist, Bank of Zambia, P.O. Box 30080, Tel: 228888, Fax:
221722; E-mail: [email protected]
ZIMBABWE
Ms. Melania Mujutywa, Economist, Ministry of Economic Development, P/B 7772,
Causeway, Harare, Tel: 263 794571, E-mail: [email protected]
CS/TCM/SEMINAR/TMMP/I/8
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COMESA SECRETARIAT
Dr. Charles L. Chanthunya, Director, Trade, Customs and Monetary Affairs, E-mail:
[email protected]
Mr. Ibrahim Zeidy, Senior Monetary Economist, E-mail: [email protected]
Mrs. Rosemary P. Manuwele, Secretary, E-mail: [email protected]
Ms Loliwe Jere, Secretary, E-mail: [email protected]
INTERPRETERS/INTERPRÈTES
Mr. Paul Kaunda, Consultant, P.O. Box 320288, Woodlands, Lusaka, Tel: 097154715, Fax: 265831; E-mail: [email protected]
Mr. John Licati Kabala, Manager, International Relations, ZAMPOST, P.O. Box
71845, Ndola, Tel: 095 717898, Fax: 02-614831; E-mail: [email protected]
Mr. Douglas-Paul Kapenda, Zambia Alliance Française Director-Ndola, P.O. Box
73001, Ndola, Tel: 095 434791; E-mail: [email protected]
Mr. Jonathan Kabaso Kazembe, Interpreter, Lusaka, Tel: 097-504881; E-mail:
[email protected]