Monetary Transmission Mechanism in the East African Community: An Empirical Investigation

Abstract

Do changes in monetary policy affect inflation and output in the East African Community (EAC)? We find that (i) Monetary Transmission Mechanism (MTM) tends to be generally weak when using standard statistical inferences, but somewhat strong when using non-standard inference methods; (ii) when MTM is present, the precise transmission channels and their importance differ across countries; and (iii) reserve money and the policy rate, two frequently used instruments of monetary policy, sometimes move in directions that exert offsetting expansionary and contractionary effects on inflation-posing challenges to harmonization of monetary policies across the EAC and transition to a future East African Monetary Union. The paper offers some suggestions for strengthening the MTM in the EAC.

A Literature Survey on Proposed African Monetary Unions

“…The findings are broadly aligned with those of Davoodi et al (2013) and are also positioned on the use of monetary policy instruments to manage economic activity. Falagiarda (2010) has suggested that, whereas a common currency area in the region is a viable option, there are some statistical and country-specific anomalies that raise some doubts on quality of findings.…”

“…(ii) an anti-thesis on papers that have recommended against the common currency area (Buigut, 2011;Rusuhuzwa & Masson, 2012;Davoodi et al, 2013;Mafusire & Brixiova, 2013;Lepetit et al, 2014;Asongu, 2014bc) and (iii) a synthesis for inquiries that have presented a case for the monetary zone, contingent on substantial policy efforts from candidate countries (Buigui & Valev, 2005 ;Falagiarda, 2010;Kishor & Ssozi, 2011;Sheik et al, 2011). From an initial assessment, like with the case of the WAMU, we find that empirical results and corresponding recommendations differ by authors, periodicity, sampled countries and methodology.…”

A Literature Survey on Proposed African Monetary Unions

“…We summarise in Table empirical studies on the proposed EAMU in a chronology that is consistent with Hegelian dialectics, notably: (i) a thesis on studies presenting a case for the monetary union (Mkenda, ; Bangaké, ; Asongu, ), (ii) an anti‐thesis on papers that have recommended against the common currency area (Buigut, ; Rusuhuzwa and Masson, ; Davoodi et al ., ; Mafusire and Brixiova, ; Lepetit et al ., ; Asongu, , ) and (iii) a synthesis for inquiries that have presented a case for the monetary zone, contingent on substantial policy efforts from candidate countries (Buigui and Valev, ; Falagiarda, ; Kishor and Ssozi, ; Sheik et al ., ). From an initial assessment, as with the case of the WAMU, we find that empirical results and corresponding recommendations differ by authors, periodicity, sampled countries and methodology.…”

“…The findings are broadly aligned with those of Davoodi et al . () and are also positioned on the use of monetary policy instruments to manage economic activity.…”

“…Moreover, mainstream policy instruments such as the interest rate and reserve capital are ineffective. Whereas Davoodi et al (2013) found mixed results about monetary policy transmission in the EAC, Berg et al (2013) used the 'narrative approach' of Romer and Romer (1989) to assess the efficacy of monetary tightening during the fuel and food shocks in 2011. They found that during this particular event monetary policy was effective at timing inflation.…”