Memoire Online - The role of National Bank of Rwanda from 1995 to 2010

I Paterne RUKUNDO, hereby declare that this dissertation entitled «the role of National bank of Rwanda on Rwandan economic development» is my own work and it has not been submitted anywhere for the award of any degree.

DEDICATION

ACKNOWLEDGEMENT

I would like first to acknowledge and thank Almighty God for loving and blessing me since my birth until now.

I thank particularly prof. RUTAZIBWA Gerard who devoted part of his time to the supervision of this work. His invaluable guidance contributed to the successful completion of this dissertation.

I recognize my parents who cared for me since the time of birth especially during the period of abolition of bursary.

I would expend my thanks to all people and best friends, especially, Mr. Augustin NDAHAYO, Mr. Augustin NIYONZIMA, Ms Egidie NIYONSABA and their families who more contributed to the achievement of this dissertation.

Thanks go to my friends and colleagues classmates in the economic department precisely to my girlfriend Clotilde MUKAMUGANGA for making my student life enjoyable.

LIST OF TABLES

APPENDICES

LIST OF ABBRAVIATIONS

ABSTRACT

The aim of this dissertation is to study how monetary policy is conducted in Rwanda by National Bank of Rwanda (BNR). The task has been accomplished by designing and estimating a Taylor rule, monetary policy reaction function for the National Bank of Rwanda over the period 1995-2010.

Applying Ordinary Least Squared (OLS) on the time series data, we test whether the Central Bank in Rwanda reacts to changes in the inflation gap, the output gap and the exchange rate. The results of the study show that the Central Bank of Rwanda has had a monetary policy over the years with the monetary stock aggregate (Mt) as the principal instrument. The results also show that the Central Bank of Rwanda reacted by giving much importance to the exchange rate than to inflation and neglected the output.

CHAPTER I: GENERAL INTRODUCTION

1.1. Introduction

Since the views of Schumpeter (1911) on the role of financial development on economic growth, strengthened by empirical works of McKinnon (1973) and Shaw (1973), and invaluable contribution of Levine (1997) who portrayed the functions through which financial development may affect economic growth, a bulk of studies have been conducted across regions and countries to provide further evidence on the link between financial development and economic growth toward development. It is in this spirit that we have undertaken this study to determine whether there is evidence of relationship between financial development supervised by National Bank of Rwanda (NBR) and economic growth in Rwanda.

This chapter presents the knowledge gap to be filled, problem statement and objectives alongside the significance, justification, identification of research and hypotheses of the study. Moreover, the chapter shows at what extend the study is relevant for Rwanda, highlights the scope and limitations, the organization of the study and summary.

The central bank is the most important institutions in a financial system. It occupies a unique position in the monetary and banking system of the country in which it operates. The central bank is always inspired by the principle of national welfare and in order to achieve this it must be done not under the influence of government, the reason being that the economy problem of the country cannot be satisfactorily solved without the fullest co-operations between the central bank and the government (Foundations of banking, 2005)

The central bank should under no circumstances compete with other banks that is receiving deposits from the public or extending loans to needy borrowers.

If it competes with other banks, this will conflict with its important function of being the bankers' bank, controller of credit and lender of last resort (comparative banking systems, 2005).

1.2. Statement of the problem

The economic growth toward development has been a major concern of the government of Rwanda by putting a lot of efforts to sustain Rwandan economy and to improve social welfare. Even though Rwandan economy has recovered considerably since the 1994 genocide; the GDP per capita is still low, around 460 US$, and over 56 percent of the population live under the poverty line. The agricultural sector, employing more than two-third of the population is underdeveloped and its contribution to GDP is still small, accounting less than 35 percent. The industry sector too seems not to be in a good position to be an alternative measure since it remained on infant stage and its contribution to GDP has never reached 20 percent. Like many other developing countries, Rwanda was also affected by global economic recession and negative effects were particularly observed in its export sector through low international commodity prices.

The economic declines significantly while the agriculture sector performed well boosted by favorable weather conditions and government green revolution program, the tightened credit conditions in the banking system.

Despite the negative effect of the global economic recession on the external sector, Rwanda managed to record a positive balance of payment, banks to relatively important foreign capital inflows. These inflows offset the current account deficit and allow Central bank to keep a comfortable external position with gross official reserves.

To avoid deeper decline of the growth rate, policy measures were undertaken by government and National Bank of Rwanda. While government kept momentum to stimulate agriculture production, the appropriate policy measures have been taken by central bank for addressing the liquidity crunch and credit to private sector conditions, with the objective of restoring confidence in the bank system.

1.3. Significance of the study

This research helps the student in partial fulfillment of the requirements of attaining a bachelor's degree and also enabled him to gain more knowledge in handling complex problems of management.

The study was intended to encourage the policy makers to closely examine the reasons why the National Bank of Rwanda must put in practice its influence on financial sector for economic stability especially by using monetary policy.

At academic level, this work will constitute an important source of data, both theoretical and practical to researchers, students from different faculties, and all the whole community.

This topic has also the interest to know the relationship of monetary policy and other macroeconomic variables.

1.4. Hypothesis

Hypothesis is an early response to questions that arose in the problem and must be confirmed to achieve a result.

By excess money supply, however there are other factors like, low level of production, high wages, high level of import rising market prices, nominal exchange rates, and macroeconomic instability, etc.

Accordingly, we argue that monetary policy is probably best served by drawing models that summarize different paradigms of the transmission mechanism, or that use of different technical approaches to represent the transmission mechanism. Taking such strategy, diversified approach to inform policy judgments is likely to reduce the risk of making serious policy errors.

I.5. Objectives of the study

The performance of the economy as reflected in factors such as law inflation rate, economic output and full employment.

The impact of financial sector through stabilizer-controller (NBR) on the economic growth towards development for Rwanda is necessary to determine whether financial sector can be viewed as an alternative pillar for future economic growth especially within the Vision 2020 framework.

v To examine the real impact of National Bank of Rwanda's activities on beneficiaries of development,

1.6. Identification of research.

It is mindset that there are many indicators of development but some of them will be selected for being estimated and others will be represented by error term.

The topic has four variables that are explained (dependent) variable and explanatory (independent) variables.

Explained variable is money stock (M_t) and the explanatory variables are output gap that is the variation of GDP and its potential (GDP Gap or GY), inflation Gap that is variation of inflation and its potential (IG) and variation of exchange rate (DEX). The model from these variables explains the role of central bank through monetary policy.

M_t= B₀ + B₁M_t-1 + B₂IG_t + B₃IG_t-1 + B₄YG_t + B₅YG_t-1 +B ₆DEX_t +B ₇DEX_t-1 + å_t

Where, M_t is money stock or quantity of money, IG_t is inflation gap, YG_tis GDP gap and DEX is variation of exchange rate.

In this research, only quantitative methods with secondary data analyzed by computer program called «E-VIEWS 3.1» will be considered.

1.7. Scope and limitations of the study

Development economic has a greater scope, in addition to being concerned with the efficient allocation existing scarce productive resources and with their sustained growth over time. It must also deal with the economic, social, political and institutional mechanisms, both public and private, necessary in level of living for the people. It means that this study is located in macroeconomics science.

The study analyses the role of National Bank of Rwanda on economic growth towards development through development of financial institutions by monetary policy covers the period of 1995 to 2010.

The topic under study may not be easy to conduct and therefore may not be properly achieved. This is merely because of the fact that there are a number of obstacles encountered in gathering data, ranging from limitations of time and finance, doubtfulness of data availability etc.

1.8. Organization of the study

As the first chapter of general introduction is seen above, the rest of the study is structured as follows: chapter two gives brief review of literature on the subject, Chapter three presents the methodology used, in chapter four we analyze data and report our results, last chapter contains conclusion and suggestions.

CHAPTER II. LITERATURE REVIEW

2.1. Introduction

This chapter presents a review of the research literature already carried out in the field under study. It is a reflection of what economic theory reveals about the topic under study and also what different researchers have come up with as empirical findings in their different studies. This review helps to understand the topic under study and also identifies different gaps of further research. Unfortunately, as shall be noticed, little has been researched in Rwanda relating to the topic under study.

2.2. Development

Development has been defined by many writers (scholars) in different ways; some argue that development involves growth of per capita income which others based on the view of improving living conditions by reducing inequality of income distribution.

According to Kocher (1973: 4), the term development is defined as the process of a general improvement in levels of living together with decreasing of inequality of income distribution and the capacity of sustaining continuous improvements overtime.

Todaro (2000: 56) defines development as a multi-dimension process involving the reorganization and the reorientation of the entire economic and social systems. He further argues that development of physical reality and a state of mind in which society has, through some combinations of social, economic and political process secured the way of obtaining better life.

2.3. Financial institutions

There are different definitions with respect to financial institutions. According to Collins (1993: 193), financial institutions are institutions that act primarily as a financial intermediary in channeling funds from lenders to borrowers (e.g commercial banks and building societies), or from savers to investors (e.g pension funds, insurance companies).

Financial institutions are institutions that move funds from people who save to people who have investments opportunities (mishkin, 2001: 179).

Financial institutions are business firms whose principal assets are financial assets or claims (stocks, bonds, loans, etc) and make loans to customers or purchase investment securities in the market place and offer other financial services (Rose et al, 1993: 11).

2.4. Financial institutions and financial system

Financial intermediaries and other financial institutions are part of a vast financial system that serves the public. The financial system is composed of a network of financial markets, institutions, businesses, households, and governments that participate in that system and regulate its operation. That system today knows no geographic or political boundaries, but girdles the globe, marking loans, issuing securities, and proving outlets for the public's savings 24 hours a day. (Rose: 1993, 6)

2.5. Functions of financial system

The basic function of the financial system is to transfer loanable funds from lenders or savings surplus units to borrowers or savings deficit units. These funds are allocated by negotiations and trading in wide web of financial markets that bring together individuals and institutions supplying funds with those demanding funds. Most savings flowing through the financial system come from households: the principal borrowers in the financial system are business firms and the government. (Rose (1993))

Rose, Kolari and Fraser (1993) further reveal that the financial system is one of the most important components of the global economy. It provides essential services without which a modern economic system could not function, thus presenting us with some roles of financial intermediation. Among these roles we analyze the important ones: credit, payments, money creation and savings.

2.5.1. Credit: the financial system supplies credit to support purchases of goods and services and to finance capital investments , construction of buildings, highways, bridges, and other structures, and the purchase of machinery and equipments.

Investment increases the productivity of society's resources and makes possible a higher standard of living for individuals and families. (Rose et al, 1993: 7)

2.5.2. Payments: the financial system supplies mechanisms for making payments in the forms of currency, checking accounts and other transactions media. In recent years institutions operating in the financial system have developed many new payment services, including money market and NOW accounts and share draft (all types of interest- bearing checking accounts), telephone bill- paying services, and electronic machines that accept deposits and dispense cash.( Rose et al, 1993: 7)

2.5.3. Money creation: through the services of supplying credit providing a mechanism for making payments, the financial system makes possible the creation of money. Although several different definitions and forms of money are in use today, all forms of money serve as medium of exchange for purchasing goods and services. (Rose et al, 1993: 7)

2.5.4. Savings: finally, the financial system provides a profitable outlet for savings. Both individuals and institutions save today to be able to consume more goods and services tomorrow. Saving performs an essential economic function because it releases scarce resources from producing goods and services for current consumption in order to produce investment goods (buildings, equipments, etc). (Rose et al, 1993: 8)

2.6. Financial development

The costs of acquiring information, enforcing contracts, and making transactions create incentives for the emergence of particular types of financial contracts, markets and intermediaries. Different types and combinations of information, enforcement, and transaction costs in conjunction with different legal, regulatory, and tax systems have motivated distinct financial contracts, markets, and intermediaries across countries and throughout history. In arising to ameliorate market frictions, financial systems naturally influence the allocation of resources across space and time. (Merton and Bodie, 1995: 12)

To organize a discussion of how financial systems influence savings and investment decisions and hence economic growth, Levine (1996) focus on five functions provided by the financial system. In easing information, enforcement, and transaction costs, financial systems provide five broad categories of services to the economy. While there are other ways to classify the functions of the financial system, we believe that the following five categories are helpful in organizing a review of the theoretical literature and tying this literature to the history of economic thought on finance and growth. In particular, financial systems:

While all financial systems provide these financial functions, there are large differences in how well financial systems provide these functions. Financial development occurs when financial instruments, markets, and intermediaries ameliorate- though do not necessarily eliminate-the effects of information, enforcement, and transactions costs. Thus, the financial development involves improvements in the above-mentioned functions.

2.7. Financial development and Economic growth

Nobel Prize Laureates and other influential economists disagree sharply about the role of the financial sector in economic growth. Finance is not even discussed in a collection of essays by the «pioneers of development economics», which includes three winners of the Nobel Prize (Meier and Seers, 1984). Nobel Laureate Robert Lucas (1988) dismisses finance as a major determinant of economic growth calling its role «over-stressed».

Joan Ribinson (1952, p. 86) famously argued that» where enterprise leads finance follows«. From this perspective, finance does not cause growth; finance responds automatically to changing demands from the «real sector».

At the other extreme, Nobel Laureate Merton Miller (1988: 14) argues that, the idea that financial markets contribute to economic growth, is a proposition too obvious for serious discussion. Similarly, Schumpeter (1912), Gurley and Shaw (1955) and McKinnon (1973) have all rejected the idea that the finance-growth nexus can be safely ignored without substantially impending our understanding of economic growth.

Resolving the debate and advancing our understanding about the role of financial sectors in economic growth has helped to distinguish among competing theories of the process of economic growth.

Furthermore, information on the importance of finance in the growth process has affected the intensity with which researchers study the determinants, consequences and evolution of financial systems. Finally, a better understanding of the finance-growth nexus may influence public policy choices since legal, regulatory, tax and macroeconomic policies all shape the operation of financial systems.

2.8. Formal financial sector and Economic activities

The formal financial sector falls under the banking law and regulations and supervision of financial authorities. It includes various kinds of banks (commercial, development and specialized, regional, cooperatives), insurance companies, social security schemes, and pension funds and some counties capital markets.

In many countries, the formal financial sector is largely urban-based and organized primarily to supply the financial needs of the wealthier population and large co-operations.

Formal financial intermediaries, such as commercial banks usually refuse to serve poor households and micro-enterprises because of the high cost of small transactions, lack of traditional collateral, and lack of basic requirements for financing and geographical isolation by doing so, these institutions ignore the economic potential in talents and entrepreneurship of this stratum of society. In many developing countries the formal financial sector serves only 5%-20% of the population and the number of institutions are very limited (Gallard A.O, 2003: 68).

However, the share of the formal financial sector in total assets is about 95% this means that poor people in developing countries depend on semi-formal and informal financial intermediaries for their credit needs.

2.9. Semi-formal financial sector and Economy

The organizations in the semi-formal financial authorities; nevertheless, they may operate under particular laws and regulations. This sector includes credit unions, non-government organizations (NGOs) and Micro Finance Institutions (MFIs). The semi-formal financial sector operates in urban as well as rural areas and is mostly dependent on subsidies and assistance from governments or donors and principally from central bank.

These contribute more significantly to rural and urban employment and purchasing power that provokes the increment of social welfare and economy in general. (Robertson, 2001: 162).

2.10. Informal financial sector and Economic activities

The informal sector is characterized in general, by social structures, individual operators, ease of access, simple procedures, rapid transactions and flexible loan terms and amounts. It includes local member-based organizations such as rotating savings and credit associations and self-help organizations. Individual money lenders also are widely found in developing countries. There are many types of informal money lenders including shopkeepers, traders, and landlords.

Last but not least, there are relatives, friends and neighbors from whom those in need can borrow, although primarily for emergencies or special purposes rather than for going working capital needs. In this situation, lenders tend to provide small loans at no or low interest, but they may expect non financial obligations in return for their credit. (Robertson, 2001: 162).

2.11. Problems affecting financial development in developing countries

One of the major factors affecting financial sector development in developing countries and Africa in particular according to Richard and Montiel (1999) is the regressive mechanisms of monetary control. Many African countries choose to repress their financial systems by adopting direct instruments of monetary policy hence preventing their financial sectors from operating at their full potential. Monetary policy in repressive regimes consists of imposition of high reserve requirements on banks as well as legal ceiling on lending and borrowing rates. Interest rates are fixes at unrealistically low rates that are often negative in real terms.

The consequence of this, is an inefficient linkage between the supply of savings and the demand for investments. The failure to signal true sacristy of capital and the flows of capital is created, and therefore unnecessary low growth of the economic is initiated.

In addition to fixing interest rates, financial repression may consist of introducing all kinds of regulations, laws and other forms of market restrictions to bank behavior and other intermediaries. Restrictions are imposed on the competition of banking industry by forming barriers to entry into the banking system or through public ownership of bank. Restrictions can also be imposed on the composition of the bank portfolio, by putting requirements that banks engage in certain form of lending, as well as prohibitions from acquiring other types of assets. It includes the imposition of liquidity ratios, requiring banks to invest specific shares of their portfolio in government instruments, as well as directed lending to specific sectors, typically the export sector and agriculture.

Besides financial repression, poor macroeconomic policy management has been noted as other serious obstacles to financial development in developing countries (Richard and Montiel, 1999). Those policies include among others; price controls, foreign exchange allocation, infrastructure bottlenecks, overvalued exchange rates, and financial mismanagement. However, Richard and Montiel (1999) believe that administered exchange and credit allocation policies may not be easy to reform because of permanent balance of payment problem and associated shortage of foreign exchange services.

African countries are also characterized by present potential instabilities, wars, conflicts and nonconductive macroeconomic environment. Such factors can increase the risk of breaking financial contracts and loosing funds and hence discourage the flow of funds into such areas.

Richard and Montiel (1999) further argue that developing countries have common microeconomic problems, which can hinder financial development. In particular they focus on the weak bank management (including lack of professional staff, inadequate capital, etc).

Furthermore, bank supervision characterized by over reliance on external audits, outdated laws, lack of surveillance capacity, and inadequate punitive control powers of central bank has received special attention from researchers.

To summarize microeconomic obstacles to financial development in Africa, Collier (1990) focused on the CAMEL framework (capital adequacy, asset quality, earnings, and liquidity).

2.12. Banking institutions

Accept money deposits from and make loans to individual consumers and businesses. Some of the most important banking institutions include: commercial banks, savings and loan associations, credit unions, and mutual savings banks. Historically, these have all been separated institutions. However, new hybrid forms of banking institutions that perform two or more of theses functions have emerged over the last two decades. The following banking institutions all have one thing in common: they are businesses whose objective is to earn money by managing, safeguarding, and lending money to others. Their sales revenues come from the fees and interest that they charge for providing these financial services. (O.C.Ferrel, 2006)

Ø Commercial banks: the largest and oldest of all financial institutions, relying mainly on checking and savings accounts as sources of loans to businesses and individuals.

Ø Savings and loans associations: are financial institutions that primarily offer savings accounts and make long term loans for residential mortgages; also called thrifts.

Ø Credit union: is a financial institution owned and controlled by its depositors who usually have a common employer, profession, trade group or religion.

Ø Mutual saving banks: are financial institutions that are similar to saving and loan associations but, like credit unions; are owned by their depositors.

Ø Insurance for banking institutions: they insure individual bank accounts.

Ø National credit union association (NCUA): is agency that regulates and charters credit unions and insures their deposits through its national credit union insurance fund.

2.13. Non banking institutions

Offer some financial services, such as short term loans or investments products, but do not accept the deposits. These include insurance companies, pension funds, mutual funds, brokerages firms, non financial firms and finance companies.

v Insurance companies: businesses that protect their clients against financial losses from certain specified risks (death, accident and theft, etc)

v Pension funds: managed investment pools set aside by individuals, corporations, unions, and some nonprofit organizations to provide retirement income for members.

v Mutual fund: an investment company that pools individual investor dollars and invests them in a large numbers of well-diversified securities.

v Brokerage firms: firms that buy and sell stocks, bonds, and other securities for their customers and provide other financial services.

2.14. Diversified firms

ü Finance companies: business that offers short term loans at substantially higher rates of interest than banks.

ü Electronic banking: since the advent of the computer ages, a wide range of technological innovations has made it possible to move money all across the world electronically. Such as paper less transaction have allowed financial institutions to reduce costs in what has been virtual competitive battle field.

· Electronic Fund Transfer (EFT): any movement of funds by means of an electronic terminal, telephone, computer or magnetic tape such transactions order a particular financial institution to subtract money from one account and add it to another. The most commonly used form of EFT are automated teller machines, automated clearing-houses, and home banking systems.

· Automatic Teller Machines (ATM): is the most familiar form of electronic banking, which dispenses cash, accepts deposits and allows balance inquires and cash transfers from one account to another. ATMs provide 24 hours banking services, both at home and far away.

· Automated Clearing Houses (ACHs): a system that permits payments such deposits or withdraws to be made to and from bank account by magnetic computer tape.

· Online banking (home banking systems): with the growth of the internet banking activities may now be carried out on a computer at home or at work, or through wireless devices such as cell phone any where there is a wireless «hot point» consumers and small businesses can now make a bewildering any of financial transactions at home or on the go 24 hours a day. (O.C.Ferrel,2006)

2.15. The role of financial system

It is inconvenient, inefficient and risky to carry around enough cash to pay for purchased goods and services. Financial institutions provide on efficient alternative. The most obvious examples are personal and commercial checking and check-clearing and credit card services, each are growing in importance, in the modern sectors at least of given low-income countries. (O.C.Ferrel, 2006)

Although many people save such as for retirement and many have investment projects, such as building of a factory or ex-pending the inventory carried by family microenterprise, it would be only the wildest of coincidences that each investor saved exactly as much as needed to finance a given project. Therefore, it is important that savers and investors somehow meet and agree on terms for loans or other forms of finance.

This can occur without financial institutions, even in highly developed markets, many new entrepreneurs obtain a significant fraction of their initial funds from family and friends. However, the presence of banks and later venture capitalists or stock markets, can greatly facilitate matching in an efficient manner. Small savers simply deposit their savings and let the bank decide where to invest them.

Financial systems play a key role in the smooth and efficient functioning of the economy;

Their most fundamental contribution is to channel resources from individuals and companies with surplus resources to those with resources deficit;

The financial system not only mobilizes the savings of the economy but also facilitates the accumulation of investment capital that is critical to growth and development. (O.C.Ferrel, 2006)

2.16. Structure of Rwandan financial sector

Rwandan financial sector is relatively small. It comprises: 8 commercial banks, 3 specialized banks (BHR, BRD and CDHR), one microfinance bank (UOPB), 122 micro finances institutions, 8 insurance companies, one public pension fund (CSR), 10 growing private pension funds.(NBR website)

2.17. Recent evolution of Rwandan banking sector

In the 1980^s a deep transformation of Rwandan financial system began. At that point, Rwandan banks were public-owned and operated under over-regulatory environment in which both lending and borrowing rates were determined by the authorities, banks were subjected to a legal service requirement which presented a compulsory credit to the government (and was the main instrument of monetary policy conditions as open market operations did not exist), and system of quotas that placed ceiling on the amount of credit that banks could provide to specific sectors.

The transformation was initiated with a profound deregulation effort. Interest rates were liberalized; the legal reserve requirement was lifted while the central bank was declared autonomous and started to use open market operations to conduct monetary policy, and cross-ownership restrictions that prevented the formation of financial groups-were removed.

In addition, in1997 a new law was approved allowing banks to participate in a wide variety of activities such mutual funds and management derivatives trading, foreign exchange dealings. This deregulation effort created the conditions to have a more competitive banking system.

After deregulation, came the privatization process. Rwandan banks had been created in 1980^s, in 2000, a presidential decree created the special committee for bank privatization.

The process was divided into two stages: 1) all groups interested in acquiring a bank had to be pre-approved on the basis of technical capability, financial situation and honorability. 2) All pre-approved groups sent their economic proposals and bank went to the highest bidders. One important condition was that, priority was given first to the Rwandan nationals.

The newly privatized banks have started to provide credit in an accelerated form. Credit outstanding to the private sector has increased from 14% of GDP in 2000 to 20% of GDP in 2005. Unfortunately, given the inexperience of some new bankers, this increase in credit was accompanied by a steep in the non-performing loans.

Banks in Rwanda are generally well run and provide a range of most important financial services. There is however room for the expansion of activities as the economy recovers; there will be scope for other institutions to enter the market.

European banking institutions have played a major role in the development of commercial banking in Rwanda. During the last 40 years, commercial banking has been dominated by three main commercial banks:

Banque Commerciale du Rwanda (BCR) was founded on 9^th April 1963 by Banque Bruxelles Lambert, it has a share capital of two billion Frw as at 31^st Dec 2001 and have six branches. BCR is one of the leading commercial banks in Rwanda. Its head office is located in Kigali at rue de la revolution. On 2^nd Oct 2004 an investment company owned by Actis Africa fund acquired 80% share in BCR and 19.8% are still in government hands and the remaining of 0.2% in hands of some private investors.

Banque de Kigali s.a (BK) created on 22^nd Dec 1966 and began its activities on 17^th Jan 1967. At the beginning, it had a share capital of 40 million Frw divided into 20,000 shares.

Fina Bank s.a formerly known as Banque Continentale Africaine duRwanda (BACAR) established in 1983 by Banque Continentale du Luxembourg. The bank was liquidated on orders of the national bank of Rwanda (NBR) for it had provided its insolvency beyond a reasonable doubts and the government of Rwanda owner of 80% of the shares.

Later the bank's assets were sold to commercial company dealing in petroleum products called FINA and it renamed FINA BANK. It continues to carry out commercial activities and it is now being owned privately.

However, other commercial banks have emerged after the resume of activities from the 1994 genocide.

Banque de Commerce, de Development et d'Industries (BCDI) which become Ecobank, established in 1995 with a share capital of 1.1 billion Frw.

Banque à la confiance d'Or (BANCOR) created in 1995 but has been acquired by new owners. And then there is a Companie Generale des Banques (COGEBANQUE) that was created in July 1999.

Throughout the early times of 1980^s was a period of moderate economic growth, total assests of the commercial banks increased by 70% between 1982 and 1986, while the ratio of average total commercial bnks to GDP increased from 9.2% to 12.6% (NBR, 1996: 143).

Although the Rwandan government has equal participation in all six commercial banks, their day to day management has been largely the responsibility of the foreign shareholders. However, Rwandan commercial banks are undercapitalized and their loan loss provisions are inadequate. This combined with the excessive concentration in a few priority economic activities makes commercial banking system quite vulnerable. (Rwanda financial sector review,2004: 143).

The commercial banking market is characterized by the concentration of its business activities in Kigali, where between 80% and 90% of all bank banking transactions are carried out (BNR; 1999: 146). Each bank strives to win over a core group of approximately 50 major customers, in respect of both deposits and loans. The three largest commercial banks have offices outside Kigali essentially to capture deposits transfer funds abroad. BCDI opened three offices in the border areas, which started operating after 2001. NBR (2001).

2.18. Monetary policy

It is first responsibility of central bank, Means by which central bank uses to control amount of balancing money available in the economy for demand and supply. (O.C. Ferrell et al, 2006)

2.18.1 Theory on monetary policy

Monetary policy is the process by which the government, central bank, or monetary authority of a country controls (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest to attain a set of objectives oriented towards the growth and stability of the economy. Monetary theory provides insight into how to craft optimal monetary policy.

Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment.

Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (to achieve policy goals).

If policymakers believe that private agents anticipate low inflation, they have an incentive to adopt an expansionist monetary policy (where the marginal benefit of increasing economic output outweighs the marginal cost of inflation); however, assuming private agents have rational expectations, they know that policymakers have this incentive. Hence, private agents know that if they anticipate low inflation, an expansionist policy will be adopted that causes a rise in inflation. Consequently, (unless policymakers can make their announcement of low inflation credible), private agents expect high inflation. This anticipation is fulfilled through adaptive expectation (wage-setting behavior); so, there is higher inflation (without the benefit of increased output). Hence, unless credible announcements can be made, expansionary monetary policy will fail.

While a central bank might have a favorable reputation due to good performance in conducting monetary policy, the same central bank might not have chosen any particular form of commitment (such as targeting a certain range for inflation).

Reputation plays a crucial role in determining how much markets would believe the announcement of a particular commitment to a policy goal but both concepts should not be assimilated. Also, note that under rational expectations, it is not necessary for the policymaker to have established its reputation through past policy actions; as an example, the reputation of the head of the central bank might be derived entirely from his or her ideology, professional background, public statements, etc.

In fact it has been argued that to prevent some pathologies related to the time inconsistency of monetary policy implementation (in particular excessive inflation), the head of a central bank should have a larger distaste for inflation than the rest of the economy on average. Hence the reputation of a particular central bank is not necessary tied to past performance, but rather to particular institutional arrangements that the markets can use to form inflation expectations.

Despite the frequent discussion of credibility as it relates to monetary policy, the exact meaning of credibility is rarely defined. Such lack of clarity can serve to lead policy away from what is believed to be the most beneficial. For example, capability to serve the public interest is one definition of credibility often associated with central banks.

The reliability with which a central bank keeps its promises is also a common definition. While everyone most likely agrees a central bank should not lie to the public, wide disagreement exists on how a central bank can best serve the public interest. Therefore, lack of definition can lead people to believe they are supporting one particular policy of credibility when they are really supporting another. ( B.M. Friedman, 2001)

Open market operations: refers to decisions to buy or sell the T-bills and investments in the open market. This monetary tool is the most commonly employed of all central banks operations, is performed almost daily in an effort to control the money supply

Reserve requirement: is the percentage of deposits that banking institutions must hold in reserve. Funds so held are not available for businesses and consumers. Because the reserve requirement has such a powerful effect on the money supply, the central bank does not change it very often, relying instead on open market operations most of the time.

Discount rate: is the rate of interest the central bank charges to loan money to any banking institution to meet reserve requirements.

Credit control: the authority to establish and enforce credit rules for financial institutions and some private investors.

Regulatory function: second responsibility of central bank is to regulate banking institutions that are members of central bank.

Accordingly, the National Bank of Rwanda establishes and enforces banking rules that affect monetary policy and the overall level of the competition between different banks. It determines which non-banking activities, such as brokerage services, leasing and insurance, are appropriate for banks and which should be prohibited.

The National Bank of Rwanda is also responsible for supervising the central insurance funds that protects the deposits of member institution. (O.C. Ferrell et al, 2006)

2.19. Bank credit and transmission of monetary policy

For modern industrial countries the usual point for a discussion of monetary transmission channels is the effect of monetary on interest rates. Policy changes are transmitted from interest rates to aggregate demand through various channels, first, increase in interest rates reduce the expenditure of private non financial sector by raising the cost of obtaining funds. Second, expenditure of private non financial sector is curbed by negative quantities and land.

Third, interest rates affect the exchange rates and stimulate the economy by changing the international price competitiveness of domestic firms. These combined channels of monetary policy have become known as «money view» of the monetary policy. (Carlos Serrano, 2001: 65).

Several conditions must be presented simultaneously for a bank credit channel of monetary policy to operate (Kashap and Stein, 1994: 278).first, monetary policy must be able to affect the total volume of bank intermediation (securities and loans).

Reserve requirement impose on deposit liabilities are argument for monetary control, but not all bank liabilities are subjected to reserve requirements. Banks can borrow (CDs, equity, bonds loans) to finance intermediation. Even if bank credit is special, the leverage of monetary policy over bank lending may be limited. (Romer, 1990: 51).

According to (Gorton and Pennacchi, 1993: 333), the increase in research on a credit channel for monetary policy can be attributed to four main motives: 1) Desire for new policy instruments in addition to the traditional instrument money supply or interest rates.

They argued that, a bank credit channel might allow central bank actions to affect the real spending of borrowers directly and improve the trade-off between inflation and output objectives, or exchange rate and domestic economic objectives. This concept of credit controls is reminiscent of policies used in many countries. 2) Reduced the share of bank credit in the total amount of funds available to the private sector.

Thonton (1994: 71) and Ceccetti (1995: 30), contend that, if the economic effect of monetary policy depends on the influence that the central bank has on the lending behavior of commercial banks, monetary policy may be in danger of losing its effectiveness.

Furthermore, some authors have argued that deregulation, innovation and global integration of financial market tend to reduce the influence of central bank on market interest rates. While bank credit becomes a reduced factor in funding the private sector, central banks may increasingly have to rely on bank credit channel to affect the economy. 3) To examine the credit channel is to develop a more reliable information variable for monetary policy. The experience in many countries is that the short-run relationship between money aggregates and the economy tends to breakdown time to time. If the credit channel is important, bank credit aggregates may be more reliable indicators of monetary policy effects than money aggregates (Friedman, 1983: 353), changes in the way banks create deposit money may provide useful information on the relationship between money and economy. 4) Use of credit channel is strengthened the case for the proposition that monetary policy affects the real economy. Despite a large body of statistical evidence in favor of short run real effects of monetary policy, the transmission mechanisms remain unclear.

It has remained a somewhat troublesome proposition that relatively small changes on real interest rates cause such pronounced effects on investment, consumer expenditure (Bernanke and Gertler, 1995).

Bernanke and Blinder (1988: 78), Greenwald and Stiglitz (1990: 149) show how interaction with bank credit increases the real effect of monetary policy, while at the same time mitigating the effect on market interest rates.

Bernanke and Blinder (1988: 79) argue that, uses of credit channel dependent on the relationship between money effects and bank credit; effects on economic activity.

Money and bank credit are two sides of the same balance sheet and bank loans are the main source of the expansion of the deposit money in the modern fractional-reserve banking systems. The money view of the transmission of monetary policy contends that, as a first approximation, the volume and the composition of bank credit is important.

2.20. Role of a central bank

In developed nations, the central bank, conduct a wide range of banking, regulatory and supervisory functions. They have a substantial public responsibilities and abroad array of executive powers. Their major activities can be grouped into five general functions:

Central bank prints money, distributes notes and coins, intervenes in foreign-exchange markets to regulate the national currency's rate of exchange with other currencies and manage foreign assets reserves to maintain the external value of the national currency.

Central bank provides bank deposit and borrowing facilities to the government while simultaneously acting as the government's fiscal agent and under writer.

Central bank also provides bank deposit and borrowing facilities to commercial banks and act as a lender of last resort to financially troubled commercial banks.

Central bank ensures that commercial bank and other financial institutions conduct their business prudently and in accordance with relevant laws and regulations. It also monitors reserve ratio requirements and supervise the conduct of local and regional banks.

Central bank attempts to manipulate monetary and credit policy instruments (the domestic money supply, the discount rate, foreign exchange rate, commercial bank reserve ratio requirement, etc) to achieve major macroeconomic objectives such as controlling inflation. (Rose, 1993)

CHAPTER III: METHODOLOGY

3.1. Introduction

This chapter explains in few words how the research has been conducted. It gives the plan, strategy research design that is required for the study. Plan includes what is done from writing the hypotheses and their operational implications to the final analysis of data. Strategy includes the methods to be used to gather and analyze the data and implies how the research objectives was reached and how the problems encountered will be tacked (Kerlinger, 1973: 300)

The study covers the period of 1995-2010. It includes explanatory variables that explain the money stock. These variables are typically of those identified in most studies of role of central bank. The money stock has been used as the dependent variable in the estimation. The study employs an econometric technique of cointegration methodology. The data that are used in this study are secondary data obtained from Ministry of Economics and Finance, Rwanda National Institute of Statistics publications as well as reports prepared by National Bank of Rwanda.

3.2. Data collection

3.2.1. Sources of data

Secondary data: data analysis in the econometric part of this research requires data provided by different institutions. As such, these data are secondary data. The National Bank of Rwanda is the principally source of data on Inflation, GDP, exchange rate and of course Money supply. So, figures on these indicators as well as on other that could help specify an appropriate Taylor rule model have been collected at the National Bank of Rwanda. But because a big part of the research deals with the role of Central Bank on Rwandan economic development , the national bank of Rwanda is not only a source of data.

Primary data: the methodology for the compilation of the role of National Bank of Rwanda (NBR) at the beginning of the research through monetary policy. So, staff from the national bank of Rwanda provided useful information on how the Inflation, Money stock, GDP and Exchange had been compiled during the period covered by the present research.

Because the researcher had difficulty of finding out that piece of information, it became necessary to interview the staff in charge of the research at the National Bank of Rwanda.

3.2.2. Data collection procedure

Most of the data was collected from the NBR library. Where, the staff was very helpful in the delivering the appropriate documents. Many of the documents were annual reports, but some other reading materials, like monthly publications; relevant to this study was also provided.

3.3. Data processing

3.3.1. Editing

Much of the information did not come from one source. Indeed, different publications had to be explored deeply. So, the figures from National Bank of Rwanda had to be properly arranged so as to allow for the analysis proceed.

3.3.2. Tabulation

The data from the National Bank of Rwanda have been then arranged into table format. This exercise allows for comparison between different indicators at the same period. Furthermore, it becomes possible, thanks to tables, to have an idea of trends and their possible causes in time series.

3.4. Data presentation, analysis and interpretation

The data obtained were analyzed using econometrics methodology. Money stock constitutes the dependent variable. The study employs an econometric technique of cointegration methodology.

To formulate a monetary reaction function for National Bank of Rwanda, the Taylor rule equation was adopted to the context of monetary policy in Rwanda.

Because of data availability problems for the monetary base series of Rwanda, the monetary stock aggregate (Mt) will be used as the instrument policy. Indeed, the monetary stock aggregate (M) plays an important role in Rwanda monetary policy since the National Bank of Rwanda assumed its responsibility to regulate liquidity in the economy and the data of the monetary base are frequently referred to Mt.

In respect of goal variables, inflation and output will be used. The former variable has emerged from many economists as the real goal of monetary policy in order to maintain price stability and the latter is considered as a historically objective of monetary policy in various countries.

In the context of Rwanda, the strategy used by the Central Bank is to ensure that liquidity expansion is consistent with target inflation and GDP growth levels. Thus, the modified version of Taylor's rule to be estimated can be written as:

However, recently, with number of empirical studies related to the Taylor rule, economists argue that the exchange rate would also be an essential state variable that has to be included in the model in the case of a small and open economy. On this basis, the equation (2) is extended as follow:

EX_t = the change in exchange rate in terms of the Rwandan Francs per US Dollars,

B₀ is constant term and B_1,B_2,B₃are coefficients respectively to be estimated empirically,

_t= the error term that presents all other variables which can have effects on Money stock in Rwanda.

The equation (3) can be seen as a function in which the money stock aggregate reacts to the Inflation gap, Output gap and the change in Exchange rate.

The version of the equation (3) to be empirically estimated can take a dynamic form since there is the lag response of Monetary Authority. On this basis, the equation (3) is expressed as follows:

LnMt= B₀+ lnM_t-1 + lnIG_t + lnIG_t-1 +lnYG_t + lnYG_t-1 +lnDEX_t +lnDEX_t-1 + _t (4) and finally the equation (4) become:

M_t= B₀+ B₁M_t-1 + B₂IG_t + B₃IG_t-1 +B ₄YG_t + B₅YG_t-1 +B ₆DEX_t +B₇DEX_t-1 + _t (5)

The Taylor Rule has been considered as a representation of Central Bank behavior in various countries. It provides information about the responsiveness of the monetary policy instrument to the monetary variables. Therefore, estimating the policy behavior of the Rwandan Central Bank and determining the target the Central Bank followed, is essential to the different policy implications, especially to the implementation of an accurate and successful monetary policy.

According to Mishkin (1997) six basic goals are continually mentioned by Central Banks when they discuss the objective of monetary policy:

- High employment level, - Economic growth, - Price stability, - Interest- rate stability, - Stability of financial markets, - Stability in foreign exchange rate markets.

The primary objective is to establish a model that explains well the relationship between the money stock and some macroeconomic variables in Rwanda. In addition, the qualitative and quantitative impacts of each of these variables on money stock are determined. A lot of other information is also obtained. For instance, it will be possible to know what the different partial elasticity that pertained by each variable is.

The augmented Duckey-Fuller Unit Root Test will be used for the purpose of data analysis throughout the research. According to Gujarati (1999: 455-467), it is this test which detects the stationary of a variable. Many other tests will also be conducted.

According to Gujarati (1999: 377-398), the Durbin-Watson test, the Runs test or the examination of the residuals are techniques that will be used in relation the problem of serial correlation.

3.5. Research techniques

3.5.1. Documentation

Time was devoted to searching for appropriate literature, reports and reading material containing the underpinning theory. A great deal of attention was devoted to publications on econometrics to provide the major support for the current study. Also, a number of websites have been visited not only in the intention of econometric modeling but also with the main of acquiring knowledge on money stock determinants around the globe in general and in economies similar to ours in particular. Many of these websites had information on money stock theories.

3.5.2. Computer programs

The whole work of analyzing the data was done with the help of computer programs. One search program that was used extensively in the study is E-Views 3.1. The choice of E-Views 3.1 program is constrained by the availability of programs and the appropriateness to handle the task at hand. This program is chosen because it is appropriate for this kind of research and can handle the estimations envisaged.

3.6. Limitations to the study

Some problems were encountered mostly because of the way the inflation has been compiled through the years. Indeed, prices of goods and services that entered the CPI were collected in the Kigali area only. Therefore, we do not really have data on inflation in Rwanda. What is available is only a rough approximation of reality.

It is only with the recent creation of the national institute of statistics of Rwanda that the methodology changed. Indeed, nowadays, the CPI covers data collected all over the country. Another limitation was the reliability of the data.

Because of different methodologies for compiling the monetary stock, inflation, GDP and exchange; the BNR, the Ministry of Economics and Finance (MINECOFIN) and Rwanda National Institute of Statistics (RNIS) have different values.

CHAPTER IV . MODEL ESTIMATION AND FINDINGS

4.1. Introduction

So far we have presented the literature both on theoretical and empirical side on the causality between economic development and central bank through financial development. It is now time to turn to the empirical testing of this relationship for Rwandan economy. This chapter presents the results obtained from econometric testing and discusses the meaning and reason behind the figures.

4.2. Historical background of National Bank of Rwanda (NBR)

It is most impossible to dissociate the study of Rwanda's monetary history from that of the former Congo and Burundi, since the three countries had, until 1960, a common currency issued by a common monetary authority.

At the end of 19^th century and early 20^th century, transactions in Belgian Congo was as well as in Rwanda. Burundi was rudimentary. The means of transactions used included salt, ivory, shells, copper, hoes, and axes. During the earliest days of the exploitation of railway in Belgian Congo, people used chickens to play their tickets. As in many African countries it was rather a barter economy.

In October 1912, the bank of Belgian Congo issued its first convertible bank notes of 20, 10, and 1000 francs. The circulation of these banknotes was difficult despite its extension to Rwanda-Burundi territories. (BNR handbook, 1964-89: 13).

Congo became independent on 30^th June 1960 and acquired a political status different from that of Rwanda-Burundi. Consequently, a review of statutes of the institutions common to Congo and Rwanda-Burundi was necessary. (BNR handbook, 1964: 14).

The role of decree of 21^th August 1960 established a public institution called «Banque d'emission du Rwanda et du Burundi» (B.E.R, B.) whose heard office was in Bujumbura with a branch in Kigali.

Banque d'Emission du Rwanda et du Burundi's mission was to promote the economic development, the development of human and material resources as well as currency stability.

Rwanda and Burundi common monetary system did not last for long. Political economic and psychological factors led to the dissolution of this union.

Rwanda, which was kept apart from the Leopoldville centre of influence, noticed once again that the installation of various common institutions in Bujumbura would harm its economic development. The years of economic and monetary union were just a failure, each party feeling cheated and blaming each deficiency on the other party.

The divorce between Rwanda and Burundi became a reality when the economic union was liquidated from 1^st January 1964. (BNR handbook, 1964: 15).

A liquidation committee was put in place. Its outcomes were the convention of 18^th May 1964 that put on end to the common monetary rule and to the issuing authority imparted to the B.E.R.B.

The National Bank of Rwanda, established by the law of 24^th April 1964, came into force from 19^th May 1964 with the aim of fulfilling one of its main missions, namely the issuing of currency on Rwandan territory. The B.E.R.B. rights and obligations were ex officio transmitted to the Royal Bank of Burundi (BRB) and to the National Bank of Rwanda (BNR).(BNR handbook,1964:15).

4.3. Mission of National Bank of Rwanda

Main mission of the Rwandan central bank are to ensure and maintain price stability, to enhance and maintain a stable and competitive financial system without any exclusion, to support government general economic policies, promoting investment or regulating international currency movements. (NBR, website)

4.4. Activities and Objectives of the NBR

The objectives the BNR are to preserve the value of the currency and to ensure its stability. To do so it exercises control on money supply and credit, it ensures good functioning of the money and the foreign exchange markets. It controls the working of the banking and financial system.

Being the central bank, it has the exclusive right to carry out the following activities so as to fulfill its objectives:

Issue of currency, act as a bank for the government, control foreign exchange and manage foreign services.

The NBR is the monetary authority of the state, it formulates monetary policy, supervises all banks and quite often carriers out research for economic planning purposes.

It is the duty of the NBR to ensure quality of the Rwandan francs, in times of durability, portability and more importantly ensure a stable parity with other currencies.

In its capacity as the government's bank, the NBR does hold the government accounts, administers all government transactions and lends to government, though at an interest. The NBR sells government treasury bills. In ensuring a good and effective foreign exchange market, the NBR controls and manages foreign reserves. In pursuing that, the NBR carries out the following duties:

- Fixing the exchange rate at a realistic level to ensure an equitable balance of payment and price stability.

The NBR, in its duty to ensure an effective foreign exchange market, introduced forex-bureau and liberalized the exchange rate, to be determined by forces of demand and supply.

In the domain of institution reform, on 26July 1997, the act of parliament No.11/97 was passed promulgating the National Bank's statutes. The statutes confer to the bank larger autonomy and powers than before, necessary to fulfill its mission.

With respect to the bank circular No.02/97 of August 12^th 1997 reorganizing the money market, the NBR now has autonomous authority, on the money market, since that date. (NBR, website) Important objectives of the bank are as follows: Issuing currencies, Managing foreign exchange, Reserves, Regulates the money market, Maintaining relationship with the Government and public institutions.

4.5. Used data

years	Mt	IG	YG	DEXCH(EX)
1995	62.9	-9.863	12.303	NA
1996	75.6	-4.698	19.649	6.47
1997	92.5	4.926	15.874	0.51
1998	97.8	-12.8	26.471	26.05
1999	104.2	4.48	70.009	18.81
2000	119.5	1.931	56.101	80.96
2001	130.7	-3.585	57.528	13.25
2002	144.3	4.19	75.261	28.19
2003	167.5	0.232	0.403	44.14
2004	187.4	-1.715	-0.23	61.45
2005	218.4	-3.514	0.17	-19.71
2006	286	3.307	-0.32	-6.01
2007	375.1	-2.502	-3.26	-4.8
2008	384.1	6.887	11.71	-0.2
2009	402	-4.663	25.93	21.47
2010	516.7	-6.173	3.74	244.73

4.6. Test for stationary

The footstep of this analysis is to determine whether the series are stationary or not. The ADF was used to test for stationary of these series as it provides a superior test to DF, especially in case the residuals of the regression could be serially correlated. The lag length has been automatically selected by AIC from eleven proposed lags and all three possibilities have been tested: neither intercept nor trend, intercept but no trend and both intercept and trend.

ADF Test Statistic	5.023678	1% Critical Value*		-2.7411
		5% Critical Value		-1.9658
		10% Critical Value		-1.6277
*MacKinnon critical values for rejection of hypothesis of a unit root.


Augmented Dickey-Fuller Test Equation
Dependent Variable: D(MT)
Method: Least Squares
Date: 07/20/11 Time: 09:07
Sample(adjusted): 1996 2010
Included observations: 15 after adjusting endpoints
Variable	Coefficient	Std. Error	t-Statistic	Prob.
MT(-1)	0.159544	0.031758	5.023678	0.0002
R-squared	0.322881	Mean dependent var		30.25333
Adjusted R-squared	0.322881	S.D. dependent var		33.05061
S.E. of regression	27.19644	Akaike info criterion		9.508390
Sum squared resid	10355.05	Schwarz criterion		9.555593
Log likelihood	-70.31292	Durbin-Watson stat		1.871053

As /ADF/ is greater than /5%/ critical value, MT is stationary at lag 0, level and function of none.

ADF Test Statistic	-4.663015	1% Critical Value*		-4.0113
		5% Critical Value		-3.1003
		10% Critical Value		-2.6927
*MacKinnon critical values for rejection of hypothesis of a unit root.


Augmented Dickey-Fuller Test Equation
Dependent Variable: D(IG)
Method: Least Squares
Date: 09/19/11 Time: 11:40
Sample(adjusted): 1997 2010
Included observations: 14 after adjusting endpoints
Variable	Coefficient	Std. Error	t-Statistic	Prob.
IG(-1)	-2.059676	0.441705	-4.663015	0.0007
D(IG(-1))	0.347099	0.247617	1.401760	0.1886
C	-1.341209	1.262206	-1.062591	0.3107
R-squared	0.796606	Mean dependent var		-0.105357
Adjusted R-squared	0.759626	S.D. dependent var		9.320982
S.E. of regression	4.569890	Akaike info criterion		6.064265
Sum squared resid	229.7229	Schwarz criterion		6.201206
Log likelihood	-39.44985	F-statistic		21.54115
Durbin-Watson stat	1.603652	Prob(F-statistic)		0.000157

As /ADF/ is greater than all critical values especially /5%/, IG is stationary at lag 1, level and function with intercept.

ADF Test Statistic	-4.887496	1% Critical Value*		-4.1366
		5% Critical Value		-3.1483
		10% Critical Value		-2.7180
*MacKinnon critical values for rejection of hypothesis of a unit root.


Augmented Dickey-Fuller Test Equation
Dependent Variable: D(YG,3)
Method: Least Squares
Date: 09/19/11 Time: 12:11
Sample(adjusted): 1999 2010
Included observations: 12 after adjusting endpoints
Variable	Coefficient	Std. Error	t-Statistic	Prob.
D(YG(-1),2)	-2.449332	0.501143	-4.887496	0.0009
D(YG(-1),3)	0.595279	0.284900	2.089433	0.0662
C	-1.073325	9.702328	-0.110626	0.9143
R-squared	0.832995	Mean dependent var		-4.231833
Adjusted R-squared	0.795882	S.D. dependent var		74.27310
S.E. of regression	33.55613	Akaike info criterion		10.07663
Sum squared resid	10134.12	Schwarz criterion		10.19786
Log likelihood	-57.45980	F-statistic		22.44524
Durbin-Watson stat	1.843834	Prob(F-statistic)		0.000318

As /ADF/ is greater than all critical values especially /5%/, YG is stationary at lag 1, second difference and function with intercept.

ADF Test Statistic	-4.393650	1% Critical Value		-4.1366
		5% Critical Value		-3.1483
		10% Critical Value		-2.7180
*MacKinnon critical values for rejection of hypothesis of a unit root.


Augmented Dickey-Fuller Test Equation
Dependent Variable: D(DEXCH,3)
Method: Least Squares
Date: 09/19/11 Time: 12:16
Sample(adjusted): 1999 2010
Included observations: 12 after adjusting endpoints
Variable	Coefficient	Std. Error	t-Statistic	Prob.
D(DEXCH(-1),2)	-1.616566	0.367932	-4.393650	0.0013
C	17.89631	23.68642	0.755552	0.4673
R-squared	0.658752	Mean dependent var		14.17417
Adjusted R-squared	0.624627	S.D. dependent var		133.8383
S.E. of regression	81.99966	Akaike info criterion		11.80232
Sum squared resid	67239.43	Schwarz criterion		11.88314
Log likelihood	-68.81391	F-statistic		19.30416
Durbin-Watson stat	1.534741	Prob(F-statistic)		0.001348

As /ADF/ is greater than all critical values especially /5%/, DEXCH is stationary at lag 0, second difference and function with intercept.

ADF Test Statistic	-3.699480	1% Critical Value*		-4.1366
		5% Critical Value		-3.1483
		10% Critical Value		-2.7180
*MacKinnon critical values for rejection of hypothesis of a unit root.


Augmented Dickey-Fuller Test Equation
Dependent Variable: D(M1,3)
Method: Least Squares
Date: 09/19/11 Time: 12:20
Sample(adjusted): 1999 2010
Included observations: 12 after adjusting endpoints
Variable	Coefficient	Std. Error	t-Statistic	Prob.
D(M1(-1),2)	-1.159214	0.313345	-3.699480	0.0041
C	0.034242	8.436719	0.004059	0.9968
R-squared	0.577812	Mean dependent var		0.391667
Adjusted R-squared	0.535594	S.D. dependent var		42.88315
S.E. of regression	29.22374	Akaike info criterion		9.738851
Sum squared resid	8540.268	Schwarz criterion		9.819669
Log likelihood	-56.43311	F-statistic		13.68615
Durbin-Watson stat	2.076159	Prob(F-statistic)		0.004112

As / ADF/ is greater than / 5%/ critical value, M1 is stationary at lag 0, second difference and function with intercept.

ADF Test Statistic	-4.663015	1% Critical Value*		-4.0113
		5% Critical Value		-3.1003
		10% Critical Value		-2.6927
*MacKinnon critical values for rejection of hypothesis of a unit root.


Augmented Dickey-Fuller Test Equation
Dependent Variable: D(IG)
Method: Least Squares
Date: 09/19/11 Time: 11:40
Sample(adjusted): 1997 2010
Included observations: 14 after adjusting endpoints
Variable	Coefficient	Std. Error	t-Statistic	Prob.
IG(-1)	-2.059676	0.441705	-4.663015	0.0007
D(IG(-1))	0.347099	0.247617	1.401760	0.1886
C	-1.341209	1.262206	-1.062591	0.3107
R-squared	0.796606	Mean dependent var		0.105357
Adjusted R-squared	0.759626	S.D. dependent var		9.320982
S.E. of regression	4.569890	Akaike info criterion		6.064265
Sum squared resid	229.7229	Schwarz criterion		6.201206
Log likelihood	-39.44985	F-statistic		21.54115
Durbin-Watson stat	1.603652	Prob(F-statistic)		0.000157

As /ADF/ is greater than all critical values especially /5%/, IG1 is stationary at lag 1, level and function with intercept.

ADF Test Statistic	-5.810852	1% Critical Value*		-4.1366
		5% Critical Value		-3.1483
		10% Critical Value		-2.7180
*MacKinnon critical values for rejection of hypothesis of a unit root.


Augmented Dickey-Fuller Test Equation
Dependent Variable: D(YG1,3)
Method: Least Squares
Date: 09/19/11 Time: 12:27
Sample(adjusted): 1999 2010
Included observations: 12 after adjusting endpoints
Variable	Coefficient	Std. Error	t-Statistic	Prob.
D(YG1(-1),2)	-1.539314	0.264903	-5.810852	0.0002
C	1.842228	10.71345	0.171955	0.8669
R-squared	0.771512	Mean dependent var		0.864250
Adjusted R-squared	0.748663	S.D. dependent var		74.01819
S.E. of regression	37.10790	Akaike info criterion		10.21655
Sum squared resid	13769.96	Schwarz criterion		10.29737
Log likelihood	-59.29929	F-statistic		33.76600
Durbin-Watson stat	2.583075	Prob(F-statistic)		0.000170

As /ADF/ is greater than all critical values especially /5%/, YG1 is stationary at lag 0, second difference and function with intercept.

ADF Test Statistic	-5.187147	1% Critical Value*		-4.1366
		5% Critical Value		-3.1483
		10% Critical Value		-2.7180
*MacKinnon critical values for rejection of hypothesis of a unit root.


Augmented Dickey-Fuller Test Equation
Dependent Variable: D(DEXCH1,2)
Method: Least Squares
Date: 09/19/11 Time: 12:36
Sample(adjusted): 1999 2010
Included observations: 12 after adjusting endpoints
Variable	Coefficient	Std. Error	t-Statistic	Prob.
D(DEXCH1(-1))	-1.469962	0.283386	-5.187147	0.0004
C	1.485446	10.59132	0.140251	0.8912
R-squared	0.729045	Mean dependent var		2.302500
Adjusted R-squared	0.701949	S.D. dependent var		67.19665
S.E. of regression	36.68534	Akaike info criterion		10.19364
Sum squared resid	13458.14	Schwarz criterion		10.27446
Log likelihood	-59.16186	F-statistic		26.90649
Durbin-Watson stat	2.085680	Prob(F-statistic)		0.000409

As /ADF/ is greater than all critical value /5%/, DEXCH1 is stationary at lag 0, first difference and function with intercept.

ADF Test Statistic	-4.335477	1% Critical Value*		-4.1366
		5% Critical Value		-3.1483
		10% Critical Value		-2.7180
*MacKinnon critical values for rejection of hypothesis of a unit root.


Augmented Dickey-Fuller Test Equation
Dependent Variable: D(E)
Method: Least Squares
Date: 07/20/11 Time: 09:46
Sample(adjusted): 1999 2010
Included observations: 12 after adjusting endpoints
Variable	Coefficient	Std. Error	t-Statistic	Prob.
E(-1)	-1.299467	0.299729	-4.335477	0.0015
C	16.62786	9.471546	1.755559	0.1097
R-squared	0.652734	Mean dependent var		1.986182
Adjusted R-squared	0.618007	S.D. dependent var		49.59723
S.E. of regression	30.65385	Akaike info criterion		9.834405
Sum squared resid	9396.583	Schwarz criterion		9.915223
Log likelihood	-57.00643	F-statistic		18.79636
Durbin-Watson stat	1.976710	Prob(F-statistic)		0.001477

As /ADF/ is greater than /5%/ critical value, error term is stationary at 0 lag, level and function with intercept.

As the line of cusum does not get out of the corridor, means that the parameters of the regression model are stable.

M = 48.62344 + 0.996100M1 + 1.492988IG + 2.824734IG1 - 0.549954YG + 0.099609YG1 -

DW is the zone of none autocorrelation zone and nR² > ÷² for LM (Lagrangian Multiplier or Breuch-Godfrey Test)

All coefficients have an econometric sense explained by F_critical that is greater than F_table, means that the concerned variables have an effect on current money stock aggregate.

After testing stationary for all variables and model specification, now interpretation.

4.7. INTERPRETATION OF THE RESULTS

Considering the one period lagged value of the monetary stock aggregate (M₁), one observes that one unit change in the previous period monetary stock aggregate results in about 0.99 units change in the current monetary stock aggregate, holding other variables the same. This means that, the increase of previous monetary stock aggregate by 1unit, current monetary stock aggregate will increase by 0.99 units, so there is positive relationship between the previous and the current monetary stock aggregate.

Considering the current and the one period lagged inflation gap: It is noticed that for a given change in the one period lagged deviation of the inflation from its target, the monetary stock aggregate reacts by a change of about 1.49 units to current inflation gap and by a change of about 2.8 units to one period lagged inflation gap. This means that, if inflation were 1unit point above its target, the Central Bank would increase the monetary stock aggregate by 1.49 in terms of reaction against current inflation gap, holding other things the same. Regarding the current period of inflation gap, the coefficient 1.49 can be interpreted as the change in the value of monetary stock aggregate following a unit change in current inflation gap in the same period and same sense. If inflation were 1 point above its target, the Central Bank would increase the monetary stock aggregate by 2.8 in terms of reaction against previous inflation gap, holding other things the same. Regarding the one year lagged period of inflation gap, the coefficient 2.8 can be interpreted as the change in the value of monetary stock aggregate following a unit change in previous inflation gap in the same period and same sense.

Considering the output, the results show that the Central Bank of Rwanda reacts to 1unit change in the current output gap by a change of 0.54 units in the monetary stock aggregate inversely, and by a change of 0.09 units in the monetary stock aggregate positively, holding other things the same.

Considering the exchange rate, the results show that the Central Bank of Rwanda reacts to 1unit change in the current exchange rate by a change of 0.08 in the monetary stock aggregate inversely and previous exchange rate by 0.31 in the monetary stock aggregate inversely holding other things the same.

When looking at the results more closely with the objective of highlighting the variable that has influenced monetary policy decisions over the period of study, it is apparent that the monetary authorities were mainly concerned with the exchange rate. This is relevant given the importance of the exchange rate in a small, open, and developing country especially Rwanda, in the present case. Indeed, as noted previously, the exchange rate policy in Rwanda aims at approaching a balanced level of the exchange rate, to stabilize prices, to ensure a support for the growth and to connect Rwanda's foreign exchange market to the international market. These objectives are pursued under a controlled flexible policy regime, that is, the exchange rate can fluctuate from day to day but the Central Bank attempts to influence the exchange rate by buying and selling currencies in the foreign exchange market. The impact of such interventions is to affect the monetary base. According to this fact, the exchange rate considerations play a great role in the conduct of monetary policy and this has been shown through the estimation results.

Given the fact that Rwanda has a strong dependence on assistance from multilateral financial institutions which in its turn has a real impact on the balance of payment, apparently, the importance of reacting to exchange rates seems to be relevant in Rwanda since it could limit the pressure exerted on the Rwanda currency in order to meet international prices and the debt service management. In addition, these findings about the exchange rate influence on monetary policy are consistent with the state of the Rwanda's economy from 1995 when it started to benefit from financial assistance from international institutions in the context of the Enhanced Structural Adjustment Facility (ESAF) and the Poverty Reduction and Growth Facility (PRGF). This may lead one to think that changes in the flow of international assistance could contribute to the significant changes in official reserves for the country.

CHAPTER V. CONCLUSION AND SUGGESTION

This dissertation intended to study how monetary policy was conducted in Rwanda. The task has been accomplished by designing and estimating a Taylor rule, monetary policy reaction function for the National Bank of Rwanda over the period 1995-2010.

Applying Ordinary Least Squared (OLS) on data taken from the National Bank of Rwanda, the Ministry of Economic and Finance of Rwanda and Rwanda National Institute of Statistics (RNIS) together, the study shows that the National Bank of Rwanda has had a monetary policy over the years with the monetary stock aggregates as the principal instrument.

According to the Taylor rule, monetary policy responds directly to inflation as any inflation-targeting central bank must. But it also responds to the output gap, which can be viewed as a measure of inflationary pressures.

- A previous monetary stock aggregate weight of (0.9961), which is positively related to the current monetary stock aggregate,

- Current inflation gap weight of 1.492988, which is positively related to the monetary stock aggregate,

- A previous inflation gap weight of 2.824734, which is positively related to the monetary stock aggregate,

- A Current Output gap weight of - 0.549954 that is negatively related to the monetary stock,

- A previous Output gap weight of 0.099609, which is positively related to the monetary stock aggregate,

- A Current variation of Exchange weight of - 0.088485, which is negatively related to the monetary stock,

- A previous variation of Exchange weight of - 0.311933, which is negatively related to the monetary stock.

Judging these results according to the importance of each variable weight, one may be inclined to contend that while the National Bank of Rwanda reacted to the inflation from the previous and the contemporaneous period, there was a much stronger response to the change in the previous exchange.

In general, such strong response of the National Bank of Rwanda to the exchange rate may reflect the economic environment in which the monetary policy was operating, because international aid has flow into Rwanda since 1995 in the context of various economic programs undertaken with the help of the International Monetary Fund (IMF) or World Bank (WB). In addition, the estimated results indicated a neglect of output gap as a goal variable.

Given the fact that the Rwanda Central Bank claimed to be following the objective of preserving the internal and the external value of the currency in order to maintain harmony between the pace of the money creation and that of economic growth it may be suggested that the Central Bank of Rwanda should give more consideration to the way the output changes, that is, the Central Bank should respond to the variation of output gap following the influence of its change in the economic state.

In addition, the results of this study of course, are backward looking, in the sense that they represent the relationships that existed so far in the data. It is worth noting that a forward-looking model may enable the implantation of a more successful monetary policy rule for Rwanda and there may be areas for future research.

The NBR's monetary programming could benefit from attributing a higher weight to the specification of money demand. The analysis in this dissertation shows that, despite political and economic volatility, and extensive controls, money demand, both in the short and long terms, reacts in a way consistent with economic fundamentals.

Taking this into account when planning interventions in the foreign exchange and money markets (both through changes in discount interest rates and open market operations) could help the NBR to avoid monetary overhangs and exchange rate volatility, or bursts in the core inflation rate.

· The National Bank of Rwanda should continue to promote measures that could stabilize

excess reserves. Measures could include closing the commercial bank accounts at the central bank later in the day and promoting the interbank market by reducing credit risk through more transparency (for example, an automated book-entry system).

· Based on the results of the study, it is urgent suggested that Rwandan government could take the financial sector as a pillar of economic growth which can replace non performing industrial sector and agriculture. The emphasis put on it can allow Rwanda to be the net exporter of financial services within East African Community and Commonwealth where Rwanda was admitted recently, as we do not have any comparative advantage in remaining sectors.

· The emphasis should be put on the level of financial intermediation through increase in the credit allocated to private sector. It is however important to note that the allocation of the credit should be changed from private consumption and services to agriculture and other investment projects like construction sector. Additionally, credit allocation should be based on the profitability of the investment rather than personal considerations or values.

· More so, National Bank of Rwanda should continue to accelerate the financial innovations which are currently very low, by making compulsory: distribution of ATM cards by banks upon bank account opening; and the use of credit cards as a means of payment in strong legalized supermarkets and shops, as a first step in the introduction of card-based system of payment.

· BPR S.A has provided evidence that bank branch proximity is a key factor in bank profitability. It is therefore, suggested that other commercial banks in Rwanda should open at least one branch in each district. Due to the absence of positive impact of financial innovations on economic growth explained by inflationary pressures and exchange rate depreciation, the national bank of Rwanda should put more efforts on price and exchange rate stability.

· It is important for policymakers to make credible announcements. If private agents ( consumers and firms) believe that policymakers are committed to lowering inflation, they will anticipate future prices to be lower than otherwise (how those expectations are formed is entirely different matter; compare for instance rational expectations with adaptive expectations). If an employee expects prices to be high in the future, he or she will draw up a wage contract with a high wage to match these prices. Hence, the expectation of lower wages is reflected in wage-setting behavior between employees and employers (lower wages since prices are expected to be lower) and since wages are in fact lower there is no demand pull inflation because employees are receiving a smaller wage and there is no cost push inflation because employers are paying out less

in wages. If an announcement about low-level inflation targets is made but not believed by private agents, wage-setting will anticipate high-level inflation and so wages will be higher and inflation will rise. A high wage will increase a consumer's demand ( demand pull inflation) and a firm's costs ( cost push inflation), so inflation rises. Hence, if a policymaker's announcements regarding monetary policy are not credible, policy will not have the desired effect.

· More so, Rwandan government should accelerate financial innovations which are currently very low, by making compulsory: distribution of ATM cards by banks upon bank account opening; and the use of credit cards as a means of payment in strong legalized supermarkets and shops.

BIBLIOGRAPHY

2. Bodie. Z, Kane A. and Marcus A. 2008, Essentials of Investments, McGraw -Hill International ed, 7ed, New York, USA

3. Brooks, C.,2004, Introductory Econometrics for Finance, 2nd ed, The ICMA Centre, University of Reading, Cambridge University Press

4. Frederic S.Mishkin,2004, the Economics of money, Banking, and Financial markets,7^th Edition, Columbia University

5. Greenwood, J. and Jovanovic, B. , 1990, Financial Development and the Development of Income; Journal of political economy, Vol. 98

8. Gujarati, D. 2004, Basic Econometrics, 4^th edition, The MacGraw-Hill companies.

9. Gurley, John, G, 1970, Money in the Theory of Finance, the bookings institutions

10. Kocher, James E., 1973, rural development income distribution and fertility decline, population council

11. Levine, R. and King, R.G., 1997, Financial Entrepreneurship and Growth, Theory and Evidence, Journal of Monetary Economics.

12. Lucas, R. E., 1988, the Mechanics of Economic Development, Journal of monetary economics.

14. Mankiw, N. G. (2000). Macroeconomics. 4^th Edition. New-York: Worth Publisher

18. Miller and Van Hoose, 1997, Essential Of Money, Banking, And Financial Market

19. Mishkin, F. S. (1997), The economics of money, banking and financial. 5^th Edition. Massachusetts: Addison-Wesley

21. Rose, poter s., 1993, financial institutions, understanding and managing financial services, homeword

22. Schumpeter, J.A., 1911, The Theory of Economic Development, An Inquiry into the Profits, Capital, Credit Interests and the Business Cycles, Cambridge, MA: Harvard, University press.

24. Taylor, J. B., The monetary transmission mechanism: an empirical framework. The Journal of Economic Perspectives, Vol 9

Academic course notes

Dissertations

1. Dushimumukiza, D., 2006, Correlation entre le Taux de Change et la Balance des Paiements, UNR

APPENDICES

years	GDPt	EXCHt	Mt	INFt	GDP tar	INF tar
1995	337.2	297.69	62.9	48.249	324.897	38.386
1996	431.4	304.16	75.6	13.434	411.751	8.736
1997	562.4	304.67	92.5	11.689	546.526	16.615
1998	632.1	330.72	97.8	6.842	605.629	-5.958
1999	677	349.53	104.2	-2.423	606.991	2.057
2000	732.2	430.49	119.5	3.901	676.099	5.832
2001	799.4	443.74	130.7	3.366	741.872	-0.219
2002	872.7	471.93	144.3	1.975	797.439	6.165
2003	993	516.07	167.5	7.445	992.597	7.677
2004	1,206	577.52	187.4	11.951	1,206.23	10.236
2005	1,440	557.81	218.4	9.122	1,439.83	5.608
2006	1,716	551.8	286	8.831	1,716.32	12.138
2007	2,046	547	375.1	9.081	2,049.26	6.579
2008	2,577	546.8	384.1	15.436	2,565.29	22.323
2009	2,990	568.27	402	10.4	2,964.07	5.737
2010	3,282	813	516.7	6.4	3,278.26	0.227

obs	MT	M1	IG	IG1	YG	YG1	DEXCH	DEXCH1
1995	62.9	NA	-9.863	NA	12.303	NA	NA	NA
1996	75.6	62.9	-4.698	-9.863	19.649	12.303	6.47	NA
1997	92.5	75.6	4.926	-4.698	15.874	19.649	0.51	6.47
1998	97.8	92.5	-12.8	4.926	26.471	15.874	26.05	0.51
1999	104.2	97.8	4.48	-12.8	70.009	26.471	18.81	26.05
2000	119.5	104.2	1.931	4.48	56.101	70.009	80.96	18.81
2001	130.7	119.5	-3.585	1.931	57.528	56.101	13.25	80.96
2002	144.3	130.7	4.19	-3.585	75.261	57.528	28.19	13.25
2003	167.5	144.3	0.232	4.19	0.403	75.261	44.14	28.19
2004	187.4	167.5	-1.715	0.232	-0.23	0.403	61.45	44.14
2005	218.4	187.4	-3.514	-1.715	0.17	-0.23	-19.71	61.45
2006	286	218.4	3.307	-3.514	-0.32	0.17	-6.01	-19.71
2007	375.1	286	-2.502	3.307	-3.26	-0.32	-4.8	-6.01
2008	384.1	375.1	6.887	-2.502	11.71	-3.26	-0.2	-4.8
2009	402	384.1	-4.663	6.887	25.93	11.71	21.47	-0.2
2010	516.7	402	-6.173	-4.663	3.74	25.93	244.73	21.47

			AIC		SIC			CHOOSEN LAG
	LAG	INT	INT AND TRE	NONE	INT	INT AND TRE	NONE
MT	0	9.641715	9.688929	9.50839	9.736122	9.830539	9.555593	LAG IS 0
	1	9.866872	9.887956	9.724115	10.00381	10.07054	9.815408


M1	0	9.296327	9.208122	9.206107	9.387621	9.345063	9.251754	LAG IS 0
	1	9.458962	9.25416	9.374977	9.589335	9.427991	9.461892

IG	0	6.206957	6.322018	6.14714	6.301364	6.463628	6.194343
	1	6.064265	6.142289	6.01912	6.201206	6.324877	6.110414	LAG IS 1

IG1	0	6.143109	6.098601	6.039519	6.234403	6.235541	6.085166
	1	6.097979	5.82158	5.845228	6.097979	5.99541	5.932143	LAG IS 1

YG	0	9.560466	9.683185	9.419062	9.65176	9.820126	9.464709	LAG IS 1
	1	9.790076	9.907057	9.637297	9.920449	10.08089	9.724212

YG1	0	9.612163	9.763314	9.458669	9.699078	9.893687	9.502127
	1	9.872514	10.02692	9.706344	9.993741	10.18856	9.787161	LAG IS 0

DEXCH	0	11.61242	11.63065	11.53175	11.69933	11.76102	11.57521
	1	11.88346	11.84749	11.78135	12.00469	12.00912	11.86217	LAG IS 0

DEXCH1	0	9.755819	9.832075	9.856065	9.842734	9.962448	9.899522
	1	9.988968	9.93752	10.04704	10.11019	10.09916	10.12786	LAG IS 0

R	0	10.02276	10.10345	9.930729	10.09511	10.21197	9.966901
	1	10.31132	10.20734	10.22258	10.40209	10.32838	10.2831	LAG IS 0

R1	0	10.1346	10.10586	9.995851	10.19512	10.19663	10.02611
	1	10.46616	9.93182	10.32152	10.53191	10.01948	10.36535	LAG IS 1

Dependent Variable: MT-MT(-1)
Method: Least Squares
Date: 09/19/11 Time: 10:01
Sample(adjusted): 1998 2010
Included observations: 13 after adjusting endpoints
Variable	Coefficient	Std. Error	t-Statistic	Prob.
C	28.09017	8.530250	3.293007	0.0110
IG-IG(-1)	0.499831	0.999226	0.500218	0.6304
YG-YG(-1)	-0.317961	0.348275	-0.912961	0.3879
DEXCH-DEXCH(-1)	0.222279	0.125268	1.774425	0.1139
RESID-RESID(-1)	0.515337	0.312843	1.647271	0.1381
R-squared	0.527088	Mean dependent var		32.63077
Adjusted R-squared	0.290633	S.D. dependent var		35.03913
S.E. of regression	29.51134	Akaike info criterion		9.891149
Sum squared resid	6967.352	Schwarz criterion		10.10844
Log likelihood	-59.29247	F-statistic		2.229121
Durbin-Watson stat	1.000899	Prob(F-statistic)		0.155471

After estimating the error correction model, it is found that all probabilities are greater than 5% this verifies that each explanatory variable has an effect on explained variable (MT).

Ramsey RESET Test:
F-statistic	31.08468	Probability		0.061410
Log likelihood ratio	58.04147	Probability		0.072100

Test Equation:
Dependent Variable: MT
Method: Least Squares
Date: 09/19/11 Time: 09:53
Sample: 1997 2010
Included observations: 14
Variable	Coefficient	Std. Error	t-Statistic	Prob.
C	4.001070	197.2238	0.020287	0.9857
MT(-1)	4.339922	7.446307	0.582829	0.6190
IG	-5.797933	12.89962	-0.449465	0.6971
IG(-1)	-8.277322	19.41283	-0.426384	0.7113
YG	-1.842925	4.348232	-0.423833	0.7129
YG(-1)	1.287048	2.608869	0.493336	0.6706
DEXCH	0.255345	0.632645	0.403615	0.7256
DEXCH(-1)	-0.784084	1.650993	-0.474917	0.6817
FITTED^2	-0.046524	0.054793	-0.849073	0.4853
FITTED^3	0.000276	0.000205	1.347810	0.3101
FITTED^4	-6.66E-07	3.58E-07	-1.858988	0.2041
FITTED^5	5.56E-10	2.38E-10	2.338133	0.1443
R-squared	0.999651	Mean dependent var		230.4429
Adjusted R-squared	0.997732	S.D. dependent var		137.8947
S.E. of regression	6.567172	Akaike info criterion		6.370419
Sum squared resid	86.25550	Schwarz criterion		6.918183
Log likelihood	-32.59293	F-statistic		520.8801
Durbin-Watson stat	2.655976	Prob(F-statistic)		0.001918

Ramsey RESET Test, as all probabilities are greater than 5%, this shows that the model is well specified.

DW is in the indecision zone near no autocorrelation zone, so DW is associated in the zone of no autocorrelation.

In econometric literature, it is not clear whether cointegration should be applied to only series integrated of the same order. Though Verbeck (2004) noted that the concept of cointegration can be applied to (nonstationary) integrated time series only and Dickey et al, quoted by Gujarati (2004), stipulated that Cointegration deals with the relationship among a group of variables, where (unconditionally) each has a unit root, however Brooks (2004) stressed that it is also possible to combine levels and first differenced terms in a VECM. The later therefore illustrates that cointegration can exist among variables not integrated of the same order.

Heij et al (2004) stated by gujarati (2009) developed the mathematical proof of this view where they asserted that a cointegration relationship exists between stationary and nonstationary variables. If their mathematical proof is put in simple terms, there are three possibilities in VAR with many variables: If m: the number of variables, r = rank of the matrix of coefficients and also the number of cointegration relations, therefore:

· If all variables are stationary, r = m and all roots lie outside the unit cycle

· If all variables are not stationary, r = 0, there are m unit roots or m stochastic trends.

· If some variables are stationary and others not stationary, r = 0< r < m, there are m-r unit roots, the polynomial have m-r common stochastic trends and there are r cointegrating relations.

As all variables are stationary, Johansen cointegration test has been used to determine whether there exist a long-run relationship between these variables. This test was preferred to Engle-Granger approach because in case of six variables we may have more than one cointegrating relationship (Brooks, 2004).

The role of National Bank of Rwanda from 1995 to 2010

DECLARATION

DEDICATION

ACKNOWLEDGEMENT

TABLE OF CONTENTS

LIST OF TABLES

APPENDICES

LIST OF ABBRAVIATIONS

ABSTRACT

CHAPTER I: GENERAL INTRODUCTION

1.1. Introduction

1.2. Statement of the problem

1.3. Significance of the study

.

1.4. Hypothesis

I.5. Objectives of the study

1.6. Identification of research.

1.7. Scope and limitations of the study

1.8. Organization of the study

CHAPTER II. LITERATURE REVIEW

2.1. Introduction

2.2. Development

2.3. Financial institutions

2.4. Financial institutions and financial system

2.5. Functions of financial system

2.6. Financial development

2.7. Financial development and Economic growth

2.8. Formal financial sector and Economic activities

2.9. Semi-formal financial sector and Economy

2.10. Informal financial sector and Economic activities

2.11. Problems affecting financial development in developing countries

2.12. Banking institutions

2.13. Non banking institutions

2.14. Diversified firms

2.15. The role of financial system

2.16. Structure of Rwandan financial sector

2.17. Recent evolution of Rwandan banking sector

2.18. Monetary policy

2.18.1 Theory on monetary policy

2.19. Bank credit and transmission of monetary policy

2.20. Role of a central bank

CHAPTER III: METHODOLOGY

3.1. Introduction

3.2. Data collection

3.2.1. Sources of data

3.2.2. Data collection procedure

3.3. Data processing

3.3.1. Editing

3.3.2. Tabulation

3.4. Data presentation, analysis and interpretation

3.5. Research techniques

3.5.1. Documentation

3.5.2. Computer programs

3.6. Limitations to the study

CHAPTER IV . MODEL ESTIMATION AND FINDINGS

4.1. Introduction

4.2. Historical background of National Bank of Rwanda (NBR)

4.3. Mission of National Bank of Rwanda

4.4. Activities and Objectives of the NBR

4.5. Used data

4.6. Test for stationary

4.7. INTERPRETATION OF THE RESULTS

CHAPTER V. CONCLUSION AND SUGGESTION

BIBLIOGRAPHY

Academic course notes

Dissertations

APPENDICES