Monetary Policy Transmission Mechanism in Zambia Chungu Kapembwa and Peter Zgambo

OUTLINE OF THE PRESENTATION Introduction What has been learnt in the course Unit root tests Estimation of the MTMs in Zambia Conclusions

Introduction Objectives of the presentation: Provide a summary of what has been learnt in the course so far; Test the stationarity of a selected variable (broad money); and, Estimate the MTM in Zambia. Zambia is in the process of modernising its monetary policy framework, with the objective of moving to inflation targeting. To this effect, the Bank of Zambia introduced the Policy Rate in April 2012.

INTRODUCTION (CONTD) Effectiveness of monetary policy based on any framework is dependent on the understanding of the MTMs, particularly the interest rate channel. The MTM determines how policy-induced changes in the nominal money stock or short-term interest rates impact on output and inflation. This exercise, therefore, attempts to estimate the MTM in Zambia, not only to identify the MTMs but to also provide input to discussion of the efficacy of targeting monetary aggregates or interest rates in monetary policy conduct.

WHAT HAS BEEN LEARNT IN THE COURSE Need to Assess the Macroeconomic and financial Conditions in the country which may support or hinder the transmission channels, e.g. Level of Monetization Level of Financial intermediation Level of openness of the economy In general, central banks deal with time series macroeconomic data, which may not be stationary. In view of this, empirical analysis aimed at informing policy formulation and implementation should take into account the non-stationary nature of time series data.

WHAT HAS BEEN LEARNT IN THE COURSE During the course, participants were exposed to testing for stationarity – Unit Root tests and Fisher Test. A times series that has no unit root is considered to be stationary. If time series has to be stationary by differencing it d times, a series is said to be an I(d), that is integrated of order d. Cointegration - refers to the existence of a long term relationship among the variables. Once the time series have been tested for unit roots, one may proceed to Estimate VARs and Error correction mechanisms (ECMs) and undertaking impulse responses, Granger causality tests and variance decomposition.

Unit Root Tests To carry out estimations in time series we need to ensure our variables are stationary to ensure reliability of forecasts and avoid spurious regressions. Used the ADF Unit Root Test on M2: not stationary at levels. Fisher Statistic F3 is calculated using the program shows p= 0.419496 > 0.05. M2 is found to be I(1) – Stationary after first difference. Therefore, we accept the null hypothesis that there is a unit root without the trend in the model.

VAR Estimation of the MTMs The VAR approach is used to investigate the MTM. Quarterly data is employed for the estimations. Five-variable VAR model is estimated (RGDP, CPI, M2, INTRT, EXR). Model also includes exogenous variables [oil and copper prices]. Impulse-response functions used to evaluate the impact on macroeconomic variables from monetary policy shocks.

VAR Estimation of the MTMs A five variable VAR model was estimated and tested for appropriate lag length using the lag selection criteria. Lag of 1 suggested by both the SC and HQ criterion was selected. VAR re-estimated using 1 lag and tested for stability (see chart). All roots were found to be within the unit circle. After noting that the VAR was stable, impulse response functions (IRFs) were estimated (see charts).

Stability of Estimated VAR

Impulse-Response: Broad Money M2 shocks have significant effects on output, prices and the exchange rate, but insignificant effects on the interbank rate.

Impulse-Response: Interest Rate Interbank rate has no significant impact on any of the variables

Note: From the study done using monthly data, the interbank rate appears to have become more relevant during the period 2006 – 2013. However, a significant impact is only found on the exchange rate.

VAR Summary Findings Results from VAR Model Estimations indicate that: Monetary aggregates have had a greater role in the MTM. Direct link from interest rates to output and inflation in Zambia has been weak. But exchange rate channel is visible, as evidenced by shocks to interest rates impacting on the exchange rate. Some evidence that interest rates are gaining in importance has been established.

Conclusions Available evidence suggests that monetary policy in Zambia has been transmitted mainly through monetary aggregates. Monetary transmission from interest rates to prices and output is weak, although strengthening: Too early to abandon the traditional policy focus on monetary aggregates? An important objective should be to enhance the MTM to strengthen the effectiveness of monetary policy whether delivered via monetary aggregates or through the BoZ policy rate.