Financial sector reforms and monetary policy reforms in Zambia

Simatele, Munacinga C H (2004): Financial sector reforms and monetary policy reforms in Zambia. Published in: University of Gothernburg PhD Series (February 2004)

Abstract

ABSTRACT The dissertation comprises four chapters focusing on issues concerning policy re-forms and monetary policy in Zambia. Chapter 1 briefly outlines the theoretical foundations for the reforms undertaken in Zambia since the mid 1980s and the process thereof. The main issues addressed were the removal of interest rate and credit controls, exchange rate devaluation and the use of indirect instruments in implementing monetary policy. Monetary policy also began to focus more on stabilisation through bringing the inflation rate down. The review indicates that although the control of inflation is still difficult and figures are still in double digit levels, annual inflation rates have reduced significantly compared to levels achieved in the early 1990s. The nominal exchange rate has been depreciating prompting increased intervention from the central bank. Despite the increase in nominal interest rates, real deposit rates have remained negative.

Chapter two analyses the monetary transmission mechanism in Zambia. Vector auto -regressions are estimated for the pre-reform and post-reform periods. Variance decompositions and impulse response functions are examined to see whether there are any changes observed in the monetary transmission mechanism after the reforms. Different systems are estimated in each period using alternate variables as measures of monetary policy shocks. The results show that contractionary monetary policy is followed by a fall in both output and prices. When compared, results from the two estimation periods show that both the responsiveness of prices and output to policy shocks and the magnitude of their forecast error variance decompositions explained by these variables have increased since the reforms. The results also show that the impact lags have reduced. There is evidence of the bank lending channel both before and after the reforms. Of the mechanisms estimated, the exchange rate mechanism seems to be the most important mechanism for transmission of policy shocks to both prices and output during the post-reform period.

Chapter three investigates whether monetary aggregates have useful information for predicting inflation other than that provided by inflation itself. Fore-casting experiments are conducted to see whether monetary aggregates and selected financial sector variables are useful in predicting inflation. We perform forecasting experiments and compare the performance of different models. We also estimate an error correction model of inflation. Of the monetary aggregates considered, M2 contains the most information and its growth rate significant in the inflation model. The external sector variables are also important. The results indicate that inflation exhibits a high level of inertia suggesting the presence of implicit indexation and significant inflationary expectations possibly due to past fiscal effects and low policy credibility. Overall, the foreign sector variables seem to be more important for movements in prices than monetary aggregates even in the long run.

The importance of the exchange rate to stabilisation policy in Zambia is underscored by the results obtained in chapters 2 and 3. In this paper, we pursue this idea by investigating the effect of central bank intervention on ex-change rates in Zambia. Using a GARCH (1, 1) model of the exchange rate, we simultaneously estimate the effect of cumulative intervention on the mean and variance of the exchange rate. We find that central bank intervention in the foreign exchange market increases the mean but reduces the variance of the exchange rate. The explanation leans towards speculative bandwagons and a 'leaning against the wind' strategy. Although there is no attempt to distinguish through which channel intervention operates, we argue that this is more likely to be a signalling effect rather than a portfolio balance effect. This effect operates mainly through the supply and demand of foreign exchange in the market.

• Item Type: MPRA Paper
• Language: English
• Keywords: monetary policy; financial reforms; zambia
• Subjects: E - Macroeconomics and Monetary Economics > E0 - General > E02 - Institutions and the Macroeconomy; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

Adam, C. S. (1995) “Fiscal Adjustment, Financial Liberalisation, And The Dynamics Of Inflation: Some Evidence From Zambia” World Development Vol.23(5)

Adam, C. S. (1999) “Financial Liberalization And Currency Demand In Zambia” Journal Of African Economies Vol.8(3)

Almekinders, G. J. and S. W. Eijfinger (1995). A Friction Model of Daily BundesBank and Federal Reserve Intervention. Journal of Banking and Finance 20.

Andersson, P. and Sjöö, B (2000) “Controlling Inflation During Structural Adjustment: The Case of Zambia”, HIID Development Discussion paper no.754.

Arm Index Histories London Inter-Bank Offered Rates,

AryeteeE and M Nissanke. Financial Intergration and Development: Liberalisation and Reform in Sub-Saharan Africa. Routledge, London.

Bagliano C F and Favero C A (1998). “Measuring Monetary Policy with VAR models: An Evaluation,” European Economic Review Vol.42

Baillie, R. and O. F. Humpage (1994). Post-Louvre Intervention: Did Central Banks Stabilize The Dollar? Working Paper, Federal Reserve Bank of Cleveland.

Bank for International Settlements, 2005, Foreign exchange market intervention in emerging markets: Motives, techniques and implications, BIS Paper No. 24.

Bank Of Zambia (1992). Bank Of Zambia Annual Reports. BOZ, Lusaka

Bank Of Zambia, Annual Reports, Various Years, Lusaka

Beine, M., X. Bènassy-Quèrè, and C. Lecourt (2002). Central Bank Intervention and Foreign Exchange Rates: New Evidence from FIGARCH Estimations. Journal of International Money and Finance 21.

Bell (1990)”Interaction between institutional and informal Credit Agents in Rural India” World Bank Economic Review,Vol.4

Bernanke B S (1983). “Non-Monetary Effects of the Financial Crisis in The Propagation of the Great Depression,” American Economic Review

Bernanke B s and A S Blinder (1992). “The Federal Funds Rate and Channels of Transmission”. American Economic Review

Bernanke B S and M.Gertler (1995) “Inside the Black Box: The Credit Channel of Monetary Policy Transmission. Journal of Economic Perspectives vo.l9(4).

Bigsten A an S.Kayizi-Mugerwa “The political economy of Policy Failure in Zambia,” Working Paper no.22 , Department of Economics, University of Gothenburg

Black R, V Cassino,A drew, E Hansen, B Hunt, D Rose and A Scott (1997). “The Forecasting and Policy System: The Core Model” Reserve Bank Of New Zealand, Research paper no. 43

Black, D.C., Corrigan, P. R. and Dowd, M. R. (2000) “New Dogs And Old Tricks: Do Money And Interest Rates Provide Information Content For Forecasts Of Output And Prices?,” International Journal Of Forecasting,Vol.16

Blancahrd O J and D Quah (1989). “The Dynamics Effects of AD” American Economic Review, Vol.77(4).

Blanchard O J and M W Watson (1986) “Are Business Cycles All Alike?” in The American Business Cycles: Continuity and Change edited by R J Gordon. Chicago University Press, Chicago.

Bollerslev, Tim and J.M. Woolridge (1992). Quasi Maximum Likelihood Estimation and Inference in Dynamic Models with Time Varying Co-Variances. Econometric Reviews 11.

Bonser-Neal, Catherine, and Glenn Tanner (1996). Central Bank Intervention and The Volatility of Exchange Rates: Evidence from the Options Market. Journal of International Money and Finance 15.

Brayton F and P Tinsley (1996). “A guide to the FRB/US:A Macroeconomic Model of the United States” Federal Reserve Board, Finance and Economic Discussion series Vol.42

Brayton FE Mauskopf, D Reifschneider, P Tinsley and J C Williams(1997). “The Role of Expectations in the FRB/US Macroeconomic Model.” Federal Reserve bulletin Vol.83(4)

Brekk O P and R B Johnston (1999). “Financial Sector Reform and Operations in Sequencing Financial Sector Reforms” in Sequencing Financial Sector reforms :Country Experiences and Issues edited by R B Johnston and V Sundararajan.

Browndbridge M (1996) Financial Policies and the Banking System in Zambia IDS working paper no. 32,Geneva

Caneles-Kriljenko, J. I. (2003). Foreign Exchange Intervention in Developing and Transition Countries: Results of a Survey. IMF Working Paper.

Chandra, N. and Tallman, E. W. (1996) “ The Information Content Of Financial Aggregates In Australia,” Research Discussion Paper No. 9606, Reserve Bank Of Australia.

Chandra, N. and Tallman, E. W. (1997), ” Financial Aggregates As Conditioning Information For Australian Output And Inflation,” Research Discussion Paper No. 9704, Reserve Bank Of Australia.

Christiano L J ,M Eichenbaum and C Evans (1994). “Identification and Effects of Monetary Policy Shocks” Federal reserve Bank of Chicago Working Paper no. 94-7

Collier P. and J.Gunning (1999). “Explaining African Economic Performance,” Journal Of Economic Literature vol.37(1)

Danker, D., R. A. Haas, Dale W. Henderson, S. Symanski and Ralph W. Tryon (1996). Small Empirical Models of Exchange Market Intervention: Applications to Germany, Japan, and Canada. Journal of Policy Modeling.

Disyatat, P., and G. Galati (2005). The Effectiveness of Foreign Exchange Intervention in Emerging Market Countries: Evidence Form the Czech Koruna. BIS Working Papers (172).

Domaç, Ilker and Alfonso Mendoza (2004): “Is there room for foreign exchange interventions under an inflation targeting framework?” World Bank Policy Research Working Paper, no 3288, April.

Dominguez, K (1992). In Exchange Rates and International Asset Markets. The Informational Role of Official Foreign Exchange Intervention Operations: the Signaling Hypothesis. New York: Garland Publishing Company.

Dominguez, K (1998). Central Bank Intervention and Exchange Rate Volatility, Journal of International Money and Finance 18.

Dominguez, K, and J. A. Frankel (1993). Does Foreign Exchange Intervention Matter? The Portfolio Effect. American Economic Review 83 (5).

Dureval, D. (1998), “ The Dynamics Of Chronic Inflation In Brazil,” Journal Of Business And Economic Statistics,Vol.16(4)

Dureval, D. and Ndung’u N. S. (1999) “A Dynamic Model Of Inflation For Kenya,1974-1996,” IMF Working Paper No. 99/97 Economic Research Discussion Paper (30).

Emery, K. M. (1996) “ The information content of the Paper Bill Spread”, Journal of Economics and Business vol.48

Engel, R F. (1982). Autoregressive Conditional Heteroskedasticity with Estimates of the Variance of United Kingdom Inflation. Econometrica 50, 987- 1007.

Engel, R, David M. L, and R. P. Robins (1987). Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model. Econometrica 55.

Engle, C M., and A. P. Rodriguez (1989). Tests of International CAPM with Time Varying Covariances. Journal of Applied Econometrics 4.

Engle, Charles M., and Jeffrey A. Frankel (1984). Do Asset Demand Functions Optimize over the Mean and Variance of the Real Returns? A Six Currency Test. Journal of International Economics 17.

Estrella, A. and Mishkin, F. S.(1997) “ Is There A Role For Monetary Aggregates For Conduct Of Monetary Policy?,” Journal Of Monetary Economics, Vol.40

Evans, Martin, and Richard Lyons (2001). Portfolio Balance, Price Impact and Secret Intervention. NBER Working Papers (8356).

Fatum, Rasmus, and Michael Hutchison (2002). ECB Foreign Exchange Intervention and the Euro: Institutional Framework, News and Intervention. Open Economics Review 13 (4).

Fatum, Rasmus, and Michael Hutchison (2003). Is Sterilised Foreign Exchange Intervention Effective After All? An Event Study Approach. Economic Journal 113 (2003). (487), 390-411.

Folssom, R. N. (1991), ”Extending The Equation Of Exchange: Dual Equations, For Output And Input,” Economic Enquiry Vol. Xxix Frankel, Jeffrey A. (1992). In Search of The Exchange Rate Premium: A Six Currency Test Assuming Mean-Variance Optimization. Journal of International Money and Finance 1.

Frankel, Jeffrey A.: Discussion on Catte, Pietro, Giampaolo Galli and Salvatore Rebecchini:

Friedman, B. M. (1996) “The Rise And Fall Of Money Growth Targets As Guidelines For U.S Monetary Policy,” NBER Working Paper No.5465

Friedman, B. M. and Kuttner, K. N. (1992) “Money, Income, Prices And Interest Rates,” American Economic Review, Vol.82(3)

Friedman, M. (1974) Milton Friedman’s Monetary Framework: A Debate With His Critics, University Of Chicago Press, Chicago

Fuhrer and Moore (1995) . “Inflation persistence” Quarterly Journal Of Economics Vol.110 (1)

Ghate(1988). “Informal Credit markets in Asian Developing Countries. Asian Development Review Vol.6(1).

Ghosh, A. (1992). Is It Signaling? Exchange Intervention and the Dollar Deutschemark Rate. Journal of International Economics 32.

Goodwin, P. and Lawton, R. (1999) “ On The Asymmetry Of The Symmetric MAPE,” International Journal Of Forecasting, Vol. 15.

Greenwald B and J E Stiglitz (1992). “Towards a Reformation Of Monetary Policy:Competitive Banking” NBER Working Paper no.4117

Guimarães, Roberto, and Cem Karacadag (2004). The empirics of foreign exchange intervention in emerging market economies: the cases of Mexico and Turkey. Washington, DC: IMF Working Paper 04/123, July.

Hafer, R W and Kutan, A. M. (1997) “More evidence on the Money-Output Relationship”, Economic Enquiry vol.35

Herrera, A. M. and P. Özbay, 2005. A dynamic model of central bank intervention, Central Bank of the Republic of Turkey Research Department Working Paper No. 1.

Humpage, Owen F. “The United States as an Informed Foreign-Exchange Speculator.” Journal of International Financial Markets, Institutions, and Money, 10 (2000), 287-302.

Humpage, Owen F. U.S. Intervention: Assessing the Probability of Success. Journal of Money Credit and Banking, 31 (1999), 731-47.

Hung, J. H. (1997). “Intervention Strategies and Exchange Rate Volatility: A Noise Trading Perspective,” Journal of International Money and Finance 16: 779-93.

Hussain, Fayyaz and Abdul Jalil (2007).

Hutchinson M M and C E Walsh(1992). “Empirical evidence on the Insulation properties of Fixed and flexible exchange rates: The Japanese experience”. Journal Of International Economics,Vol.32(3/4).

IMF (1999) Staff Country Report: Statistical Appendix, IMF, Washington D C.

Juselius, K. (1992) “Domestic and Foreign Effects on Prices in an Open Economy: The Case of Denmark,” Journal of Policy Modeling, vol.14.

Kadenge, P. G. (1998) “ Essays On Macro-Economic Adjustment In Zimbabwe: Inflation, Money Demand, And The Real Exchange Rate,” PhD Dissertation, Gothenburg University, Gothenburg

Kaminsky, Gabriella, and Karen Lewis (1996). Does Foreign Exchange Intervention Signal Future Monetary Policy? Journal of Monetary Economics 37.

Kashyap A K and J C Stein(1994). “Monetary Policy and Bank Lending” in Monetary Policy edited By G.Mankiw ,NBER Studies in Business Cycles Vol.29,Chicago

Kearney, C. and R. Macdonald (1985). Intervention and Sterilization under Floating Exchange Rates: The UK 1973-1983. European Economic Review 30.

Kearns, Jonathan, and Roberto Rigobón, 2005, "Identifying the efficacy of central bank interventions: evidence from Australia and Japan," Journal of International Economics, 66(1), 31-48.

Kozicki S (2000) “Why Do central Banks Monitor so Many Inflation Indicators?” Kansa federal Reserve bank Bulletin

Kuijs, L. (2002) “Monetary Policy Transmission Mechanisms And Inflation In The Slovak Republic,” IMF Working Paper No. 02/80

Larrain F. B and Sachs, J D (1993), Macroeconomics in The Global Economy, Prentice Hall, NJ

Levin A,Jrogers and B Trayon (1997). “a Guide to FRB/Global.” Federal Reserve Board

Lewis, Karen (1988a). Inflation, Risk and Asset Market Disturbances: The Mean-Variance Model Revisited. Journal International Money and Finance 7.

Lewis, Karen (1988b). Testing the Portfolio Balance Model: A Multi-Lateral Approach. Journal International Economics 24.

Lewis, Karen (1995). Occasional Interventions to Target Rates. American Economic Review 85.

Mc Callum B T and Nelson (1997). “An optimising IS-LM Specification for Monetary Policy and Business Cycle Analysis”. NBER Working Paper no.5878.

McCallum B T “Analysis of the Monetary Transmission Mechanism: Methodological Issues”. NBER Working Paper No. 7395.

Meade N. (2000), “A Note on The Robust Trend and ARARMA Methodologies in the M3 Competition,” International Journal of Forecasting Vol. 16(4)

Meltzer A H (1995). “Monetary Credit (and Other) Transmission Processes: A monetarist Perspective” Journal of Economic Perspectives vol. 9 (1).

Ministry Of Finance And Economic Development, Macroeconomic Indicators, Various Years, MOFED, Lusaka.

Mishikin F (1991). “Asymmetric information and Financial Crises: A historical Perspective” in Financial markets and financial crises edited by R G Hubbard. University of Chicago Press.

Mishikin F (1994). “Preventing Financial Crises: An international Perspective,” Manchester School Vol.62

Mishikin F(1996). “The Channels of Monetary Transmission: Lessons for Monetary Policy”. NBER Working Paper No. 5464

Mkenda K B (2001).Essays on Purchasing Power Parity ,Real Exchange Rate and Optimum Currency Areas. Ph.D Thesis University Of Gothenburg.

Montiel P(1991). “The Transmission Mechanism for Monetary Policy in Developing Countries”. IMF Staff Papers Vol.38 (1).

Mutoti, N (1997) “Demand for money and monetary Policy in Zambia” Working Paper, Economics Department, BOZ.

Mwansa, L. (1998), “Determinants Of Inflation In Zambia,” PhD Dissertation, Gothenburg University, Gothenburg

Nachenga, J. C. (2001), “ Financial Liberalization, Money Demand And Inflation In Uganda,” Imf Working Paper No. 01/118

Nannyonjo J (2001). “Monetary Policy and Credit Market imperfections : Evidence on Uganda,1994-2000”. Mimeo

Ndulo M and Simatele (1999). “Financial Services in Zambia.” Mimeo,Ministry of Commerce, Trade and Industry.

Neely, Christopher (2001). "The Practice of Central Bank Intervention: Looking under the Hood," Federal Reserve Bank St. Louis Review, pp. 1-10.

Neely, Christopher J. An Analysis of Recent Studies of the Effect of Foreign Exchange Intervention. Federal Reserve Bank of St. Louis Review, 87 (2005), 685-717.

Orden, D A. and Fisher, L A (1993) “Financial Deregulation and the Dynamics of Money, Prices and Output in New Zealand and Australia”, Journal Of Money, Credit and Banking Vol.25(2)

Özlü, Pinar, and Artem Prokhorov. (2007). Modeling central bank intervention as a threshold regression: evidence from Turkey. Ankara, Turkey: Working Paper, Research Department, CBRT.

Phillips, Llad, and John Pippenger. (1993). “Stabilization of the Canadian Dollar: 1975-1986,” Canadian Journal of Economics, 26(2): 1589-1614.

Poloz S, D Rose and R Tetlow (1994). “The Bank of Canada’s New quarterly Projections Model (QPM):An Introduction.” Bank of Canada Review.

Rabin A A and Yeager L B (1997) “The Monetary Transmission Mechanism,” Eastern economic Journal Vol.23(3).

Ramchander, S. and R. Sant (2002). Impact of Federal Reserve Intervention on Exchange Rate Volatility: Evidence from Futures Markets. Applied Financial Economics 12.

Roemer M and C Jones(1991). Markets in Developing countries: Parallel, Fragmented and Black. International Centre for Economic Growth, HIIP, San Francisco, ICS Press.

Rogers, J. M. and Pierre L. Siklos (2003). Foreign Exchange Market Intervention in Two Small Economies: The Canadian and Australian Experience. Journal of International Money and Finance 22, pp. 393-416.

Rogoff, Kenneth (1984). The Effects of Sterilized Intervention: An Analysis of Weekly Data. Journal of Monetary Economics 14.

Romer, D. (1996) Advanced Macroeconomics, McGraw-Hill company,NY.

Rotemberg J and M Woodford (1998). “An Optimisation-Based Econometric Framework For the Evaluation Of Monetary Policy,” NBER Technical Paper no.263.

Rudebusch G (1998) “Do Measures of Monetary Policy in a VAR make Sense?” International Economic Review Vol.39.

Saatcioglu, Cem, H. Levent Korap and Ara G. Volkan. Information Content of Exchange Rate Volatility: Turkish Experience. International Business & Economics Research Journal 6 (2007).

Saccomanni (eds.) The International Monetary System, Cambridge University Press, Cambridge

Sacerdoti, E. and Xiao, Y. (2001) “ Inflation Dynamics In Madagascar,1971-2000,” IMF Working Paper No. 01/168

Saikkonen, Pentti (1991). “Asymptotic Efficient Estimation of Cointegrating Regression," 7 Economic Theory, 1-21.

Sarno, Luca, and Mark P. Taylor (2001). Official Intervention in the Foreign Exchange Market: Is It Effective, And If So, How Does It Work? Journal of Economic Literature 39, 839-868.

Sims, C. (1972) “Money, Income and Causality,” American economic Review, Vol.62.

Simwaka, Kisu, and Leslie Mkandawire. (2006). The effectiveness of official intervention in foreign exchange market in Malawi. Working paper, Research and Statistics Department of the Reserve Bank of Malawi.

Söderlind P (1999). “Solutions of Macro-models with Optimality,” European Economic Review Vol.43.

Söderlind P (2001) Lecture notes in Monetary Policy: VAR Studies of Monetary Policy. Stockholm School Of Economics, Mimeo.

Statistics South Africa (2002), Annual Inflation On A Monthly Basis

Svensson L (1999). “Inflation Targeting as a monetary Policy Rule” Journal Of Monetary Economics Vol.43

Sweeney, Richard J. (2007). "Fed Intervention, Dollar Appreciation, and Systematic Risk," Journal of International Money and Finance.

Tapia, Matías, and Andrea Tokman (2004): “Effects of foreign exchange intervention under public information: the Chilean case”, Economía Lacea Journal, vol 4, Spring.

Taylor J B (1995). “The Monetary Transmission Mechanism: An Empirical Work”. Journal of Economic Perspectives vo.l9(4).

Thoma, M. A. and Gray J. A. (1998) “ Financial market variables do not Predict Real Activity”, Economic Enquiry vol.36

Von Hagen, Jürgen. (1989). Monetary Targeting With Exchange Rate Constraints: The Bundesbank in the 1980s. Federal Reserve Bank of St. Louis. Wei and Kim (1999).

Wenzel, T. (2001), “Hits-And –Misses For The Evaluation And Combination Of Forecasts,” Journal Of Applied Statistics Vol.28(6)

Willemain T. R. (1991), “The Effect Of Graphical Adjustment on Forecast Accuracy,” International Journal of Forecasting Vol.7(4)