— Fmr. Finance Minister Boima Kamara reveals; presents white paper research on the Effectiveness of Transmission Mechanism of Monetary Policy on Liberia to CBL
By David A. Yates
A white paper research on the effectiveness of transmission mechanisms of monetary policy, submitted to the Government through the Central Bank of Liberia (CBL), has recommended to the bank to strengthen its country’s foreign exchange rate policy.
The research, which was delivered to the CBL on December 7, 2020 under the banner of Liberian Professionals for Development (LPfD), headed by former Finance Minister Boima S. Kamara and former Deputy Foreign Affairs Minister for International Cooperation, Dehpue Zuo, said the research is LPfD group’s way of helping to support national development efforts.
LPfD is an independent, not-for-profit think-tank with no political affiliations established with the primary goal of organizing professional Liberians, irrespective of religious or political persuasion, around the central theme of their construction, economic and social development of Liberia.
The research further narrated that investigating the effectiveness of monetary transmission mechanisms in Liberia, the study examined the exchange rate, money supply, and bank lending channels suitable to Liberia and comparable regional member countries including Sierra Leone, The Gambia, and other developing countries.
The research said the analyses of the results from the impulse response function and forecast error variance decomposition found the interest rate to be the most effective channel in transmitting monetary policy shocks to domestic prices.
“This is important to the CBL since its primary goal is price stability. In this regard, the CBL should endeavor to strengthen the exchange rate targeting framework, probably by clearly stating a band around which the exchange rate should fluctuate,” the research noted.
Nonetheless, policy consideration should be given to the combined effects of money supply and bank lending channels on real output through better banking supervision by the CBL and enhance fiscal-monetary policy coordination that supports macroeconomic stability and ensures inclusive economic growth, job creation, and low inflation.
Also, the research said, efforts must be made towards achieving financial sector development and deepening; making the economy more cashless away from the current cash-based state; and improving currency management through optimal growth in monetary aggregate that is consistent with economic growth.
“This, the document said, will go a long way in strengthening the transmission channels in Liberia.”
At the same time, the former authors disclosed that monetary operations in Liberia have generally been limited in scope since its establishment in 1999.
The use of monetary policy rate (MPR) by the CBL, the research paper said, has been absent until September 2019 when the Monetary Policy Advisory Committee was formed and the first committee’s meeting was held in October, setting the stage for the use of MPR by the CBL. The role of interest rate has been mute.
In his research, the former Finance Minister said that the monetary policy framework of the CBL has largely been a managed float exchange rate regime—a form of exchange rate targeting based on broad exchange rate stability without a band.
In addition to influencing the bank lending channel, the research indicated that the CBL has predominantly used a combination of direct and indirect instruments including reserve requirements, foreign exchange auction, moral suasion, and most recently in 2019 monetary policy rate, CBL securities, and standing credit and deposit facilities.
“The problem here is, can one say that all of these monetary channels (i.e., exchange rate, money supply, and bank lending) are effective in impacting general price condition and economic growth or not?
“This issue, in addition to the fact that there is no empirical literature on this matter in Liberia, is the research gap that the white paper is attempting to fill and provide answers regarding the monetary channel that is most effective in transmitting monetary policy impulse to the real economy,” the research said.
The research paper further said that the aim of the study, the first on monetary transmission mechanism literature in Liberia, is to investigate empirically the effects of monetary policy on real per capita output and inflation.
The 3 channels examined according to the research were the exchange rate, money supply and bank lending.
The research also made use of Johansen cointegration technique, the vector error correction model (VECM) framework couched within a vector autoregressive (VAR) system because all of the quarterly time series were found to be integrated of the same order, in this case I (1) for the reviewed period 2006Q1 and 2019Q4.
A monetary operation in Liberia has generally been limited in scope since its establishment in 1999.
The monetary policy framework of the CBL has largely been a managed float exchange rate regime—a form of exchange rate targeting based on broad exchange rate stability without a band.
In addition to high growth in monetary aggregates, the CBL at times engaged banks by doing US and Liberia placements at commercial banks to influence expansion of credit to the private sector at reduced cost of funds and longer tenor on loans repayment.
This investigation is motivated by the fact that there is a gap in the empirical literature in Liberia and is the first empirical research assessing monetary policy transmission mechanism in Liberia; a desire to find empirical evidence that will help inform academic discussions and policy; and to help position Liberia for the inevitable transition from dual currency regime to single as long as it remains a part of the regional economic bloc (ECOWAS) that is about to implement the protocol on monetary union.
Of the 3 channels examined, the paper established evidence for monetary transmission with exchange rate as the effective channel in transmitting monetary policy impulse to domestic prices, explaining an average of 88.0 percent variation in future inflation; but proved a poor predictor of future real per capita output.
This outcome is important for the monetary authority suggesting the need to strengthen the exchange rate targeting framework.
However, the combined effects of money supply and banking channels were found to be effective in transmitting monetary impulses to output.
The research paper said that this calls for better policy coordination between the fiscal and monetary authorities to ensure macroeconomic stability that guarantees inclusive growth, job creation and low inflation.