The impact of monetary policy on consumer price index (CPI): 1985-2010
par Sylvie NIBEZA
Kigali Independent University (ULK) - Master Degree 2014
This chapter presents the summary of the study and it provides conclusions and recommendations.
The research study on the impact of monetary policy on Consumer price index was conducted by taking NBR as a case study. Our main purpose was to evaluate the use of monetary policy and the specific objectives were to describe strategies of monetary policy in stabilizing economy and to determine the impact of monetary policy on Consumer price index (CPI).
To achieve the desired objectives, the researcher consulted different documents on monetary policy and collected Secondary data on different time series where they obtained data were tested for stationarity in order to avoid regression involving non-stationary variables which can lead to misleading inferences. ADF and PP tests were used to check for stationarity. Engle- Granger two steps procedure and the Johansen Maximum Likelihood Methodology were used to see whether variables are co integrated or not. All those two tests revealed that there is no cointegration among our variables. And this has leaded us to the use of impulse response in order to estimate the impacts of monetary policy on Consumer price index (CPI).
The research found that the National Bank of Rwanda uses different tools of monetary policy in order to stabilize economy. It uses them in attempting to achieve the objectives of the monetary policy. With those tools, money supply, credit, interest rates and other monetary variables can be manipulated by the central bank of Rwanda in order to stabilize Rwandan economy. When the central bank wants to reduce money supply or credit availability, it sells the securities to the public. On the other hand if the central bank wants to increase money supply and credit availability, it buys securities from the public. The central bank can manipulate the reserve requirements in order to influence money available to commercial banks and the public.
When the central bank wants the money supply reduced, it increases the reserves required and by reducing it, it increases money supply.
The central bank can achieve its objective by charging high or low discount rate to commercial banks depending on its desire. Whenever, the central bank wants a reduction in money supply, it raises the bank rate and vice versa. By selling or buying foreign exchange, the Central Bank ensures that the exchange rate is at levels that do not affect domestic money supply in undesired direction.
With a direct credit control, the available savings can be allocated and investment can be directed in particular directions. And the central bank can persuade commercial banks to follow certain paths such as credit restraint or expansion, increased savings mobilization and promotion of exports through financial support, which otherwise they may not do, on the basis of their risk/return assessment.
By using tools of econometrics, the research founds that the monetary policy can affect the Consumer price index (CPI) and the following have been found:
ü The nominal exchange rate has been increasing during the period under consideration .And an increase in nominal exchange rate of Rwanda has an effect of increasing quickly inflation in the first year, and in the second year it becomes stationary while it increases again in the third year and becomes stationary in the following years. In general, the increase in nominal exchange rate has an effect of increasing the inflation in Rwanda as the blue line is above the natural path.
ü The nominal interest rate has also been increasing .Increase of nominal interest rate in Rwanda has an effect of decreasing inflation in the first two years. However, in the third year, inflation increases again and reaches its level of beginning in the fourth and fifth year. In the following years, inflation is found to decrease.
ü Money supply has been found to increase during the period under consideration, but it decreased considerably in 2006, but from that year, the money supply started also to increase again. When there is an increase in money supply in Rwanda, inflation decreases considerably in the first year. However, in the second year, inflation start increasing again and it reaches its original level in the seventh but it increases again in the tenth year.