REACTION AND IMPACT OF MONETARY POLICY ON WAMZ ECONOMIES REACTION AND IMPACT OF MONETARY POLICY ON WAMZ ECONOMIES. By Abwakwa Englama, Ismaila Jarju and Edward Nyarko

OUTLINE INTRODUCTION THEORETICAL LITERATURE EMPIRICAL LITERATURE METHODOLOGY ESTIMATED RESULTS CONCLUSION POLICY RECOMMENDATIONS

INTRODUCTION The debate regarding effectiveness of monetary policy and how central banks react to the business cycle have been two protracted contentions among economists. Research on the issues have largely focused on developed economies. Those on developing economies have cantered largely on a few WAMZ countries.

INTRODUCTION The study is relevant because of the growing concern about; WAMZ Member States’ inability to attain and/or maintain all the convergence criteria for WAMZ monetary integration; High domestic interest rates, low growth recorded at both aggregate and sectoral levels; The vulnerability of the zone to external shocks;

INTRODUCTION The objective of the Study is to investigate how WAMZ central banks react to fluctuations in output, inflation and exchange rates and how such policies in turn, affect these indicators.

Theoretical Literature Review Theoretical views on Effectiveness of Monetary Policy: Old Classical money neutrality argument Orthodox Keynesian non-neutrality Orthodox Monetarist New Classical /Monetary Equilibrium Business Cycle Theory (MEBCT) The Real Equilibrium Business Cycle Theory (REBCT)

Theoretical Literature Review Theoretical views on Cost of Disinflationary Monetary Policy: the Original Phillips curve of Orthodox Keynesian school Expectation- augmented Phillips curve by Monetarist New Classical School/ the MEBCT explanation

Theoretical Literature Review Theoretical views on Monetary Policy Transmission Mechanism Mishkin (1996, 2007) : Interest Rate Channel Credit channel’ Exchnage Rate Channel Asset Price Channel( Stock Price ,Real Estate etc.) Expectations Channel

Empirical Literature Effectiveness of Monetary Policy: Studies (such as Mishkin, 2002; Christiano et al., 1999; Rafiq and Mallick, 2008 and Bernake et al., 2005) which were conducted on developed economies like the United States (U.S) and some core European countries, the results showed that the impact of monetary policy on real economic variables are significant. Studies conducted on WAMZ economies and other developing countries on the other hand, found absence or weak empirical support for monetary policy effectiveness (for such as  Obafemi and Ifere 2015;Chuku ,2009; Balolgun, 2007; Odusola, 2005; Uchendu, 1996; Adamgbe, 2004 and Nnanna, 2001).

Empirical Literature Monetary Policy Reaction Function: The famous Taylor rule (1993, 1995, 1998a, 1998b, 1999) describes the relationship between the U.S. federal funds rate (FFR), the output gap and the inflation gap. Clarida, Gali and Gertler (1998), estimated monetary policy reaction functions for two sets of countries, the G3 (U.S., Japan, and Germany) and E3 (U.K., France, and Italy) using Generalized Method of Moments.

Monetary Policy Framework of WAMZ Central Banks COUNTRY THE GAMBIA GHANA GUINEA LIBERIA NIGERIA SIERRA LEONE Policy Framework Monetary Aggregate Targeting Inflation-targeting Exchange rate Targeting Primary Objective Price Stability Exchange rate and Price Stability Operational Target Reserve Money Monetary Policy Rate Intermediate Target Broad Money Short-term Interbank rate and annual Inflation target Exchange Rate Broad Money and short-term interbank rate. Ultimate Target Annual CPI inflation rate Of 5% Explicit Medium CPI inflation rate of (8%+/-2) CPI inflation rate CPI inflation rate (6-9%) Monetary Operation Instruments Open market operations, Reserve Requirement and Rediscount facility Open market operations, Reserve Requirement and Standing Deposit and Lending Facility Reserve Requirement and Rediscount Facility Forex Interventions, Open market operations, Reserve Requirement and Cash Reserve Requirement and forex Net Open Position and Liquidity Ratio Reserve Requirement, Rediscount facility Source :IMF(2016), WAMI and Central Banks of WAMZ

Financial Markets in The WAMZ SUB-MARKET THE GAMBIA GHANA GUINEA LIBERIA NIGERIA SIERRA LEONE Money market   Gov't Securities YES Yes Interbank Market Yes but shallow Yes but Shallow Capital Market Stock Exchange None Over-the-counter market YES but capitalization Small Fund management Market Private equity/Venture Capital Yes but basic Derivative Market Forward,futures,Options,Swaps etc shallow and limited to a few banks Insurance General, life, non-life etc Pensions Private Public Source :WAMI

Xt = [OIMP, IMTt, PSCt, DNERt, INFGAPt, YGAP ] METHODOLOGY Study uses Structural Vector Autoregressive (SVAR) We define Xt as a vector of endogenous and policy variables: Xt = [OIMP, IMTt, PSCt, DNERt, INFGAPt, YGAP ] We specify a structural VAR to represent a WAMZ economy as follows:

Data and Definition of Variables for each WAMZ Country. GHANA THE GAMBIA, GUINEA,SIERRA LEONE LIBERIA NIGERIA OIMP Monetary Policy Rate (MPR) Reserve Money (LRM) External Reserve (LXR) IMTt Average Interbank Rate (INTB) Broad Money (LM2) PSCt Percentage of Credit to Private Sector (PSC) Value of Price Sector Credit (LPSC) Nominal Exchange rate (LNER) Value of Price Sector Credit( LPSC) DNERt Nominal Exchange rate(LNER) CPI inflation ( LCPI) INFGAPt Deviation of CPI Inflation from 10% Target (LCPI_GAP) Real Output (LY) YGAP of Potential Ouput() minus Actual output (Y_GAP)

Estimated Results The Gambia Ghana

Estimated Results Guinea Liberia

Estimated Results Nigeria Sierra Leone

CPI INFLATION/INFLATION GAP REAL OUTPUT/OUTPUT GAP Empirical Results Monetary Policy Reaction: The results show that WAMZ central banks generally react quickly to macroeconomic fluctuations as shown in the table below. COUNTRY EXCHANGE RATE CPI INFLATION/INFLATION GAP REAL OUTPUT/OUTPUT GAP THE GAMBIA YES NO GHANA GUINEA LIBERIA NIGERIA SIERRA LEONE

Empirical Results Transmission Mechanism: In respect of the channels of monetary policy transmission, the study found that the interest rate, the credit and the exchange rate channels to be the most dominant in the zone. COUNTRY INTEREST RATE CHANNEL CREDIT CHANNEL EXCHANGE RATE THE GAMBIA not estimated YES GHANA GUINEA LIBERIA NIGERIA SIERRA LEONE

Empirical Results A striking observation from the results of the study is that whilst transmission of monetary impulses from operating targets to the intermediates target appears effective for all WAMZ economies, the transmission from intermediate targets to ultimate target and the real economy appears weak and slow. It was also found that the pass-through of exchange rate to inflation is significant and quick, explaining why most central banks in the zone show quick response to exchange rate developments

Empirical Results In addition, it was revealed that monetary contraction significantly and in relatively limited time, squeezes credit to private sector and contracts output in most WAMZ countries, indicating high sacrifice ratio.

Conclusion The results of the study revealed that WAMZ central banks actively and quickly respond to fluctuations in general prices, exchange rates and output. However, due to the limited scope or weaknesses in channels of monetary policy transmission, the effectiveness of monetary policy is generally constrained in economies of the zone. The study also observed that disinflationary monetary contraction results in quick and sizable squeeze in credit to private sector as well as reduction in output, indicating sizeable sacrifice ratio

Recommendations Central banks in the zone need to continue improving their monetary policy frameworks, building robust forecasting models and enhancing staff capacity. Building of strong statistical database and improving data collection methodology as well as developing indices and conducting surveys for assessing developments and impact of policy on the real economy are essential.

Recommendations Member countries should endeavour to widen the scope of monetary policy channels by deepening financial markets in the zone, particularly in the Gambia, Guinea, Liberia and Sierra Leone where markets are relatively shallow and limited to money market activities. Capital markets developments should also be intensified in all member countries through financial integration of the zone.

Recommendations In view of shallowness of financial markets in the zone and weaknesses in monetary policy transmission, it is essential for central banks to consider some appropriate direct intervention programmes to reduce the sacrifice ratio of contractionary monetary policy. Key sectors like agriculture and manufacturing should be given some direct interventions as continuous monetary contraction to fight inflation with its associated interest rate hikes has the tendency to hurt output in such strategic but credit-risky sectors of the economy.  

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