The impact of monetary policy on consumer price index (CPI): 1985-2010
par Sylvie NIBEZA
Kigali Independent University (ULK) - Master Degree 2014
In order to evaluate the use of monetary policy, the researcher carried out a research with the following specific objectives: to determine the impact of monetary policy on Consumer price index (CPI).and to describe strategies of monetary policy in stabilizing economy.
In order to achieve those objectives, documentary research has been done on Strategies of monetary policy in stabilizing economy and tools of econometrics have been used in order to analyze the collected data and all that led to the following:
ü Open market operation , reserve requirements , discount rate, selling or buying foreign exchange, direct credit control and moral suasion are the different strategies that the central bank of Rwanda uses in 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 achieve predetermined policy goals. This becomes possible because the central bank is the one which designs and implements monetary policy on behalf of the government. It has the duty of ensuring economic stability of a country. It is the one which is responsible for issuing money in accordance with the level of economic activities.
ü The Rwandan currency has been depreciating during the period under consideration. However, a depreciation of Rwandan currency has been found to increase inflation in Rwanda. This increase of inflation resulting from the depreciation of Rwandan currency is as expected by theories and given the structure of Consumer price index (CPI). Normally, when there is a depreciation of a country's currency, the theory predicts that the country's exports become cheap while its imports become expensive. That is why, for Rwanda, when the Rwandan currency gets depreciated, it becomes easy to export while it is difficult to import. Or, as we know the structure of Rwandan economy, Rwanda does not have more things to export and it is obliged to import some goods in order to survive.
That is why, when there a depreciation of Rwandan currency, Rwanda becomes obliged to import goods which became more expensive and this brings inflation in Rwanda.
ü The nominal interest rate has also been increasing. That increase in nominal interest rate can be explained by fact that the central bank of Rwanda has been increasing the bank rate charged to commercial banks. And when commercial banks are charged a higher interest rate, they likewise charge a higher interest rate to the borrowers. The central bank raised the bank rate may be by a desire of reducing the money supply in order to curb inflation.
This is logical because increase in nominal interest rate discourages people to ask for loans and consequently reduces money into circulation. So, when there is a problem of inflation in Rwanda, the monetary authorities may increase the nominal interest rate which has an effect of reducing money into circulation and decrease inflation in the country. However, that happens only in the first two years because in the following years, inflation increases and reaches its original level.
This increase in inflation resulting from the increase in nominal interest rate is due to the fact that a high interest rate can discourage investment which discourages production. So, the scarcity of production on local market pushes prices up and brings prices to increase.
ü Findings reveal that 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. Also, 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. That is why, when monetary authorities realize a need of stimulating production, they increase money into circulation.
That increased money is invested into productive activities which increase production in Rwanda. That increase in production results in reduction of prices in the first year. However, it has been seen that the continual increase of money supply push again prices up in the following years and prices reaches its original level in the seventh year.