2. Monetary Policy Effectiveness in Sub-Saharan Africa

International Monetary Fund. African Dept.
Published Date:
October 2010
  • ShareShare
Show Summary Details

Introduction and Summary

Monetary authorities in sub-Saharan African countries have experienced significant challenges in managing a period of inflationary pressures (2007–08) and, soon after, recessionary pressures (2008–09), both coming from abroad. It is accordingly an opportune time to take stock of the experiences and efficacy of the monetary policy response to these recent challenges. Indeed, with fiscal policy space narrowing, monetary policy is likely to take center stage in managing economic shocks in coming months, underscoring the importance of strengthening its effectiveness. To address these issues, this chapter asks the following questions:

  • How did the monetary authorities react to the global shocks of recent years?
  • How effective was monetary policy in achieving policymakers’ objectives?
  • How can policies be adopted to improve the effectiveness of monetary policy?

The main conclusions are as follows:

  • The authorities reacted to the recent global shocks, although sometimes with a delay. Overall, they reacted with moderate tightening in response to a perceived temporary shock (food and fuel price), followed by loosening as global growth slowed.
  • Monetary policy is more effective in sub-Saharan Africa than is perhaps commonly believed. Changes in base money growth and policy interest rates feed through to changes in broader monetary aggregates and market interest rates, respectively, with the impact larger in sub-Saharan Africa than other broad country groupings. Linkages from interest rates to economic activity and inflation are weaker, and global factors are also at work.
  • Nominal exchange rate flexibility has played a role as a shock absorber during these two shocks, facilitating current account adjustment. For countries with fixed exchange rates, reserve buffers have been useful for financing current account deficits.
  • Monetary authorities often face policy dilemmas that complicate macroeconomic stabilization in sub-Saharan Africa. These dilemmas are associated with the nature of shocks hitting sub-Saharan African economies. During the recent crisis, reserve money growth and the discount rate have sometimes moved in directions that exert offsetting expansionary and contractionary impulses (with Zambia offering a typical example).
  • In many sub-Saharan African countries, the major constraints to the monetary transmission mechanism include a high level of excess liquidity in the financial system, underdeveloped financial markets, and substantial monetary financing of fiscal deficits (fiscal dominance). Countries should address these issues in order to make monetary policy more effective.

Recent Shocks and the Policy Response

Sub-Saharan Africa was hit by sizable shocks to food and oil prices in 2007–08 and by the global financial crisis in 2009. The buildup of prices was large in a historical context with food and oil prices rising to their highest levels since the 1970s (Figure 2.1). In late 2008, these prices declined markedly with the onset of the global financial crisis. And the global economic slowdown triggered by the crisis was, by far, the most pronounced over the last forty years (Figure 2.2).

Figure 2.1.World Commodity Prices

Source: IMF, World Economic Outlook.

Figure 2.2.World Growth

Source: IMF, World Economic Outlook.

How Did the Monetary Authorities Perceive and React to the Shocks?

Assessments of current conditions and near-term outlooks were dramatically revised during 2008–09 as global price and demand shocks swept across the region. Successive vintages of World Economic Outlook forecasts—which are based on IMF staff’s discussions with authorities on country prospects and policies—illustrate the way perceptions evolved in real time during the period (Figure 2.3).

Figure 2.3.Revisions to Inflation and Growth Forecasts

Source: IMF, World Economic Outlook.

Forecasts in early 2008 expected current year inflation to increase only marginally, even though global food, metal, and energy prices had risen steeply since early 2007. But, by October 2008 additional data led to a sharp upward revision of 3½ percentage points on average for 2008 and 3 percentage points for 2009.

The outlook for growth in 2009 remained strong and largely unchanged during the rising inflation episode of 2008, but between October 2008 and April 2009, forecasts dropped by an average of 3½ percentage points. Oil exporters were especially hard hit, and countries with fixed exchange rate regimes fared worse than floaters (Box 1). All groups anticipated a rebound in 2010, although with forecasts remaining well below precrisis expectations. Interestingly, despite the collapse in anticipated growth, the outlook for inflation continued to rise between October 2008 and April 2009, though pressure was expected to abate quickly. Inflation outcomes were diverse, depending on local market conditions and on the impact of policies to control or subsidize food and fuel prices. On average, inflation peaked early in 2008:Q3 at about 16 percent, 10 percentage points above the second half of 2007 (Figure 2.4).

Figure 2.4.Frequency of Changes in Inflation

Sources: IMF, International Financial Statistics; and IMF staff estimates.

With most central banks in the region targeting interest rates and reserve money growth at different times depending on circumstances, it is useful to consider the relationship between both of these instruments and broader banking and economic aggregates. In terms of policy interest rates, monetary authorities generally responded to inflationary pressures by raising them (Figure 2.5). Increases were, however, modest and the average rate in the region edged up by only ½–1 percentage point, resulting in highly negative ex post real rates.

Figure 2.5.Frequency of Changes in Policy Rates

Sources: IMF, International Financial Statistics; and IMF staff estimates.

This measured response is consistent with a supply shock that was expected to be transitory. With inflationary expectations contained and adequate financing available to cover transitory impacts on the balance of payments and fiscal accounts, policy makers might reasonably have chosen to implement countercyclical stabilization policies to smooth demand and accommodate transitory price pressures. Policy rates also responded to global market conditions, including risk premiums. From October 2008, the preponderance of policy rate changes led to an easing in the monetary stance, lowering the average policy rate to 8 percent, the lowest for many years. In non-oil countries with floating regimes, policy rates followed a global interest rate index (comprising the Libor and the Emerging Market Bond Index (EMBI) spread), although at a much higher level and with a lag of about one quarter (Figure 2.6). Policy rates in non-oil fixed rate countries were at a similar level and moved synchronously with the global index, but the response was more muted.

Figure 2.6.Sub-Saharan Africa: Policy Rates

Sources: IMF, International Financial Statistics; and IMF staff estimates.

Changes in reserve money growth provide an alternative measure of policy changes. Oil exporters had extreme volatility in monetary growth (because of changes in foreign reserves linked to commodity prices), compared with almost no movement in interest rates (Figure 2.7). At the other extreme, non-oil floating exchange rate countries, which hiked and later cut their discount rates by about 4–6 percentage points, chose to raise reserve money growth during the commodity price shock but lowered it as inflationary pressures abated. Non-oil fixed exchange rate countries experienced considerable reserve money growth volatility during the price shock but also subsequently lowered reserve money growth as inflation subsided.

Figure 2.7.Sub-Saharan Africa: Reserve Money Growth

Sources: IMF, International Financial Statistics; and IMF staff estimates.

While the monetary response was broadly as expected in terms of nominal interest rates—first a moderate tightening to accommodate most of the first round of the price shock, followed by a reduction as the external environment deteriorated and growth began to slow—inflation developments reversed this countercyclical response. Real rates turned negative with the spike in inflation in 2008, but subsequently rose as inflation plummeted, at the same time that growth started slowing down.

In retrospect, monetary policy might have been loosened more aggressively at that point, though in light of rising risk premiums, the scope for reducing policy rates without triggering more outflows is unclear (see discussion of risk premiums and exchange rates in the next section). Moreover, average nominal policy rates by mid-2009 were the lowest they had ever been.

How Did Monetary Policy Affect Macroeconomic Performance?

In response to changing global and domestic conditions, countries in the region used their monetary instruments to varying degrees, as discussed above. Naturally, monetary policy has limitations, particularly in addressing large and complex shocks such as those experienced during 2007–09, and is constrained by institutional and structural characteristics. However, such limitations, while different in nature, are not unique to the region. For example, many advanced countries at the moment face the zero lower bound on interest rates. The important question for sub-Saharan African countries is how effective monetary policy actions are in stabilizing economic conditions—including output and inflation—given the various constraints. To gauge this, we proceed as follows in this section.1

Box 2.1.Classification of Exchange Rate Regimes

This chapter categorizes the many exchange rate regimes into three broad groups: oil exporters, oil importers with pegged exchange rate arrangements, and oil importers that are money targeters. The exchange rate regime classification follows the latest IMF de facto classification.

Oil ExportersOil Importers
Fixed/Pegged/Crawling Peg Exchange RateMonetary and Inflation Targeters
CameroonBotswanaCongo, Democratic Republic of
ChadBurkina FasoEthiopia2
Congo, Republic ofCape VerdeGambia
Equatorial GuineaCentral African RepublicGhana3
NigeriaCote d’IvoireKenya
SenegalSão Tomé & Príncipe4
Seychelles1Sierra Leone
SwazilandSouth Africa

Seychelles became a money targeter in November 2008.

Ethiopia officially has a crawling peg arrangement against the U.S. dollar but is classified under money targeters in this chapter in view of its repeated devaluations in recent years.

Ghana has been an inflation targeter since 2007.

São Tomé & Príncipe became pegged to the euro as of January 2010.

Seychelles became a money targeter in November 2008.

Ethiopia officially has a crawling peg arrangement against the U.S. dollar but is classified under money targeters in this chapter in view of its repeated devaluations in recent years.

Ghana has been an inflation targeter since 2007.

São Tomé & Príncipe became pegged to the euro as of January 2010.

This box was prepared by Alun Thomas.
  • We first consider the transmission of monetary policy through the interest rate and credit channel. Our approach is to analyze the transmission of changes in central bank instruments to the banking sector (using bivariate regressions) and in a second stage the link between banking sector and outcome variables (growth, inflation, broad monetary aggregates, and the exchange rate) through a vector autoregression (VAR).
  • We then look at the exchange rate channel emphasizing on how the outcome variables evolved in countries with fixed versus floating exchange rate regimes.

Interest Rate and Credit Channels

Typically, central banks change policy rates with a view to affecting lending and deposit rates offered by banks. This in turn induces changes in the behavior of the general public. How effective are central banks in influencing commercial banks’ interest rates? To examine this effectiveness, we consider bivariate regressions of changes in interest rates and changes in reserve money.

  • Changes in bank lending and deposit rates are closely associated with changes in the central bank policy rate, with the association stronger for policy rate increases. Since 1995, central bank discount rates have had a stronger contemporaneous correlation with lending rates in sub-Saharan Africa than in Organization for Economic Co-operation and Development (OECD) countries (Box 2.2).2 When lagged effects are taken into account, the OECD linkage becomes slightly stronger. For sub-Saharan African countries, these linkages are heterogeneous, with the CFA zone, South Africa common monetary area, Gambia, and Malawi experiencing almost full pass-through of the policy to lending rate (27 countries in all) and 6 other sub-Saharan African countries experiencing relatively little pass-through. The banking sector in many sub-Saharan African countries is highly concentrated, so banks may try to take advantage of an increase in the policy rate to expand their lending profit margins, while keeping lending rates fixed downward with policy rate movement. Indeed, there is evidence for an asymmetrically higher pass-through to lending and deposit rates when policy rates increase. However, the difference is economically small (5 basis points).
  • Reserve money and broad money growth are strongly related, reflecting limited monetization among African countries. After allowing for lagged effects, an additional 1 percent rise in reserve money growth translates into a 0.32 percent rise in broad money for the median sub-Saharan African country, but has almost no impact in OECD countries (Box 2.2). This strong link between reserve money and broad money is notable given the use of reserve money targeting in most sub-Saharan African countries with floating rate regimes. However, this partly reflects the underdevelopment of the banking system, so that reserve money and the common component of currency in circulation account for a larger share of broad money. Before the global crisis and quantitative easing, reserve money constituted less than 10 percent of broad money in advanced countries, compared with more than 30 percent in most African countries.

Whereas central bank actions affect lending and deposit rates and broad money, interest rate and liquidity changes in the banking sector must also affect economic activity for policy to effect stabilization.

Box 2.2.Empirical Evidence on the Credit and Interest Rate Channels in Sub-Saharan Africa

To understand the effectiveness of credit and interest rate channels, we first analyze the transmission of changes in central bank instruments to the banking sector and as a second stage the link between the banking sector and the rest of the economy. Evidence for sub-Saharan Africa on the link between central bank and deposit bank interest rates and between reserve money and broad money is shown in Table 1. It presents results of bivariate regressions on monthly data based on the specification in Mishra, Montiel, and Spilimbergo (2010). The regressions are conducted for each individual country and take the general form:

Table 1.Monetary Transmission in Sub-Saharan Africa
xDiscount RateReserve MoneyDiscount RateReserve Money
yLending RateDeposit RateBroad MoneyLending RateDeposit RateBroad Money
Sub-Saharan Africa
Contemporaneous impact
Long-run impact
Contemporaneous impact
Long-run impact
Source: IMF; International Finance Statistics ; and IMF staff estimates.
Source: IMF; International Finance Statistics ; and IMF staff estimates.

The contemporaneous impact of x on y is captured by β1, and the long-run effect is given by βlr=i=15βi/(1i=69βi). The table summarizes the 75th percentile, median, and 25th percentile country results for the contemporaneous and long-run effects of each pair of independent and dependent variables. The results for sub-Saharan African countries are compared with results from OECD countries as a benchmark.

This box was prepared by Valerie Cerra.

VARs are a standard method for investigating the full monetary transmission mechanism, including the impact on real economic activity and inflation. A panel VAR was estimated for sub-Saharan African countries (oil countries were excluded given the extreme volatility of data) for real GDP growth, inflation, deposit bank credit growth to the private sector, the real lending rate, reserve money growth, the real discount rate, broad money growth, and exchange rate depreciation relative to the U.S. dollar (Figure 2.8). Exogenous variables include global food and oil prices, global interest rates, and G-7 industrial production. The VAR spans 2001–09, using monthly data (expressed on an annualized basis) for all variables except annual real GDP (which holds the same value for each month in the year). We considered separately the impact of a positive shock to the discount rate and reserve money since both of these targets are used at different times by central banks in the region. The main findings are as follows:

Figure 2.8.VAR Model of Monetary Transmission

Sources: IMF, International Financial Statistics; and IMF staff estimates.

  • A positive shock to reserve money growth generates increases in output growth, inflation, and monetary aggregates, and leads to exchange rate depreciation in floating rate regimes. Real interest rates become negative, although the results are not significant. These changes are all in the direction we would expect a priori. The effects of reserve money growth on inflation strengthen over time. The broader message here is the importance of money as a determinant of inflation in most countries in the region whereas the weak link between money and inflation has led most advanced countries to focus on interest rates as the key monetary policy variable (Figure 2.9). It seems therefore that monitoring the evolution of reserve money in most sub-Saharan African countries is of some importance.
  • An increase in the discount rate depresses growth, but, somewhat anomalously, increases inflation and depreciates the exchange rate. Growth and deposit money banks’ credit to the private sector both slow in response to a hike in the discount rate, but inflation rises. This phenomenon has been observed in similar studies for advanced countries (the “price puzzle”) and may simply reflect central bankers increasing interest rates in anticipation of increases in inflation.3,4

Figure 2.9.Sub-Saharan Africa and Advanced Economies: Inflation and Base Money

Sources: IMF, International Financial Statistics; and IMF staff estimates.

Offsetting Policy Instrument Effects

Monetary instruments do not always move in tandem because of the nature of shocks hitting the sub-Saharan African economies. Reserve money growth and the discount rate sometimes move in directions that exert offsetting expansionary and contractionary impulses. Indeed, since 1995, as well as in the recent period of the global shocks, monthly changes in the discount rate and reserve money growth are uncorrelated contemporaneously. This lack of relationship may also help explain the “price puzzle” mentioned above. That is, the increase in the discount rate may be associated with a rise in inflation because authorities are partially accommodating supply shocks through an increase in reserve money growth.

Some insight on this issue can be obtained from a case study of Zambia during the commodity shock and global crisis (Box 2.3 and IMF Country Report No. 10/208). Initially following the global commodity price shock, monetary authorities allowed higher reserve money growth to accommodate the shock, partly as they assumed it would be temporary and partly to help finance the fiscal budget. Meanwhile, nonperforming loans (NPLs) started to rise and banks’ risk appetites waned. As banks shifted their portfolios to excess reserves, private credit and broad money slumped. Given these developments, combined with lags in monetary transmission, the central bank was sanguine that the reserve money growth would not fuel inflation. Reserve money growth shot up from single digits to about 40 percent over the course of 2008. At the same time, higher domestic and global risk premiums depressed foreign interest in Zambian government securities, requiring an increase in interest rates to shore up demand. In short, policy interest rates and money growth both rose during 2008.

The Zambia case study illustrates monetary policy conduct and challenges in response to supply shocks. A negative supply shock leads to lower economic growth and higher inflation. But as growth slows, profitability declines and risk premiums on loans and securities increase. Thus, interest rates may rise even as the central bank tries to loosen monetary conditions. The rise in risk premiums and the decline in banks’ asset quality may then weaken the interest rate and credit channels of monetary transmission.

In sub-Saharan Africa, there is a reasonably strong link between changes in policy interest rates and commercial bank lending and deposit rates. Moreover, the central bank is able to affect growth somewhat through this channel. However, the influence of monetary policy on growth is weakened by supply shocks and changes in risk premiums at times of global turbulence.

Exchange Rate Channel

In this section, we consider how countries with different exchange rate regimes fared in terms of stabilizing inflation and output during the last few years. For ease of analysis, we use the three-way classification noted earlier in Box 1 comprising oil-exporters, most of which fix their exchange rates to the U.S. dollar or euro (7 countries); oil-importing countries with fixed exchange rates (17 countries); and oil-importing countries with floating exchange rates (19 countries).

Nominal exchange rates in countries with fixed exchange rate regimes have remained stable throughout the period of commodity price shocks and the financial crisis, although the currencies of oil exporters, especially those closely aligned to the U.S. dollar, followed the commodity price cycle (Figure 2.10). For the floaters, currencies depreciated somewhat with the onset of the global food and fuel price shock and there was a more pronounced depreciation once the global recession commenced.

Figure 2.10.Sub-Saharan Africa: Nominal and Real Effective Exchange Rates

Sources: IMF, International Financial Statistics; and IMF staff estimates.

But perhaps the most interesting development is that, as of mid-2010, real effective exchange rates for the three groupings were all some 10–15 percent more appreciated relative to their levels in early 2006. Floaters experienced sizable inflationary impulses during the price shock that were only partly offset by nominal depreciations. Their real effective exchange rates were some 10 percent more appreciated as of July 2010 than four years earlier. Real exchange rates of oil exporters and the non-oil fixers have evolved in a broadly similar fashion5 with both groups experiencing more limited depreciations in effective terms and still enough inflation to end up with a real exchange rate appreciation of broadly the same magnitude as the floaters. The interesting question is how different growth and balance of payments outcomes have been in the floating-regime countries that have witnessed considerably more movement in nominal exchange rates.


For floaters, the bilateral exchange rates against the U.S. dollar have been closely aligned with the U.S. dollar Treasury bill rate and with the EMBI spread since 2003, with the relationship having strengthened considerably over time (Table 2.1). Since 2007, the coefficients indicate that a 1 percent decline in the U.S. Treasury bill rate leads to a local currency appreciation of about ½ percent whereas a decline in the EMBI spread by 1 percent leads to a local currency appreciation of the same magnitude. The inflation rate of the floaters was more adversely affected by the commodity price shocks than countries with fixed currencies but the recent sizable depreciation among this group has not reignited inflation. Comparing movements in the real exchange rate with changes in real policy interest rates reveals that the two components of the monetary stance moved in opposite directions during 2008 as inflation reached its peak, but the situation has reversed subsequently.

Table 2.1.Determinants of Bilateral U.S. Dollar Exchange Rate Change

(National currency per U.S. dollar)1

U.S. Treasury bill rate0.35 ***0.47 ***
EMBI interest rate spread0.61 ***1.08 ***
DW statistic1.951.98
Countries (number)1414
Sources: IMF, International Financial Statistics; and IMF staff estimates.Note: *** 1% significance; ** 5% significance; * 10% significance.

With controls for domestic money growth, inflation, U.S. inflation, and the lagged real exchange rate.

Sources: IMF, International Financial Statistics; and IMF staff estimates.Note: *** 1% significance; ** 5% significance; * 10% significance.

With controls for domestic money growth, inflation, U.S. inflation, and the lagged real exchange rate.

How did the recent events affect growth and the current account among floaters? The non-oil floaters have experienced strong growth in recent years, averaging more than 6 percent in 2007 and 2008. However, growth subsided considerably to 4 percent in 2009 and contributed to a moderation in imports. During this period, the flexible exchange rate helped to cushion current account adjustments because it only deteriorated by only about 1 percentage point of GDP between 2007 and 2009.

Box 2.3.A Model-Based Analysis of Monetary Policy in Low-Income Countries during the Crisis: The Case of Zambia

A structural model can help to make sense of economic developments where reduced form correlations are difficult to interpret. This box uses a small, simple, but sophisticated model developed by the IMF’s African and Research Departments in an ongoing joint project, to analyze how monetary policy responded to external shocks hitting Zambia in 2008–09. Zambia is in many ways a representative of sub-Saharan African low-income country. It is dependent on commodity exports (copper) and shocks to export and import prices play an important role. Financial markets are thin and access limited, attenuating the direct impacts of interest rates on economic activity, though bank lending remains important.

In 2008–09, Zambia experienced in rapid sequence the impact of the food/fuel price shock followed by the global financial crisis. We interpret this period as being driven mainly by two external shocks: the terms of trade and country risk premium. The latter is not readily observable but can be inferred from the observed trajectory of the nominal exchange rate. We thus simulate the combined effects of the observed movements of the terms of trade and the exchange rate, looking to see how the model helps us understand the behavior of the rest of the key variables in the face of these shocks. Figure 1 (panels 1 and 2) shows the sharp decline in the country’s terms of trade, reflecting the collapse in the price of copper—Zambia’s main export—and depreciation of the nominal exchange rate from mid-2008 through early 2009 and subsequent recovery.

Figure 1.Zambia: External Shocks and Monetary Policy, 2008–09

Sources: IMF, International Financial Statistics; and IMF staff estimates.

Monetary policy: The Bank of Zambia targets monetary aggregates while the exchange rate floats. In the model, the lending rate depends on the value of private firms, reflecting the notion that banks become less willing to lend when the value of firms declines. We capture the Bank of Zambia’s monetary policy in 2008–09 by choosing the trajectory of reserve money that reproduces observed 90 days Treasury bill rates. The third panel of Figure 1 shows how the Treasury bill interest rate increased somewhat early in 2009 and then collapsed toward the end of the year. Figure 2 shows that the model’s logic tracks fairly well the evolution of reserve money, commercial bank lending rates, and CPI inflation. In particular, note how the rise in the nominal Treasury bill rates in mid-2009 required a decline in high-powered money, but after 3–4 quarters, policy was loosened and the Treasury bill rates fell sharply.

Figure 2.Zambia: Model-Based Projections, Selected Variable, 2008–09

Sources: IMF, International Financial Statistics; and IMF staff estimates.

Despite the looser policy stance, lending rates continued to rise substantially (second panel of Figure 2). In the model, this occurs because the negative trade shock reduces real activity and thus the implied value of firms. This in turn makes bank loans riskier, leading banks to demand higher spreads between lending and Treasury bill rates for a given quantity of lending to the private sector. This is consistent with the rise in NPLs observed in Zambia over this period. The higher lending rates further depress domestic demand, with the result that inflation comes down fairly quickly.

Why were policy rates (briefly) tightened in early 2009? As Figure 2 shows, inflation was fairly high in late 2008/early 2009, reflecting the past effects of the 2008 food/fuel price shock. At the same time, exchange rate was weakening sharply. It may have seemed appropriate then to tighten monetary policy to fight inflation and perhaps resist the nominal depreciation. However, because the model is structural, we can use it to ask whether a different monetary policy response might have mitigated some of the effects of the shocks. Indeed, additional results (not shown) suggest that higher initial money growth would have diminished the increase in lending rates relative to the baseline, mitigating the decline in domestic demand, at a cost of slightly higher but still declining inflation.

Beyond helping to understand events in Zambia, the model-based exercise illustrates a number of points of more general interest:

  • Care must be taken in interpreting reduced-form correlations. For example, lending rates and short-term rates may move in opposite directions, as in Zambia in 2008/2009, even when, as in the model as calibrated to Zambia, monetary policy remains at least somewhat effective.
  • The rapid sequence of first, food/fuel prices and second, the global financial crisis shows the need for forward-looking policymaking. It is risky to drive by looking only at the rear-view mirror, as with monetary policy risks, which are excessively tight when a loosening is required.
This box was prepared by Alfredo Baldini, Jaromir Benes, Andy Berg, Mai C. Dao, and Rafael Portillo.

Although the real effective exchange rate appreciated marginally more for the floaters during this period, the deterioration in the current account was moderated by import prices rising more than domestic substitutes facilitating a decline in the import-to-GDP ratio by 2½ percent over the two-year period. With less current account adjustment needed, reserve movements were fairly modest (Figure 2.11).

Figure 2.11.Sub-Saharan Africa: Reserves and Exchange Rate Movements

Sources: IMF, International Financial Statistics; and IMF staff estimates.


For the fixers, nominal and real exchange rate movements were muted, with the fixed exchange rates helping to contain inflationary pressures. Indeed, oil exporters with fixed exchange rates had the lowest inflation rates during the commodity price boom (August 2007–August 2008), perhaps owing to subsidization. Although subject to less inflationary pressure than the floaters, real policy interest rates fell by more among the fixers during 2008 but have subsequently rebounded as inflation fell and the real exchange rate stabilized.

For the non-oil fixers, output growth was less impressive than for the floaters during 2007–08 at 3½ percent, but subsided by the same magnitude to 1½ percent in 2009. Without the benefit of exchange rate adjustment, the current account deteriorated considerably among these economies between 2007 and 2009 (average decline of 2½ percent of GDP) with the average decline in the import ratio at only ½ percent. Without nominal exchange rate adjustment, non-oil fixers made greater use of reserve changes to finance the current account deterioration. Between August 2008 (the eve of the financial crisis) and June 2009, nominal exchange rates for fixed exchange rate regimes varied between ± 2 percent while changes in reserves varied between ± 30 percent (Figure 2.11). Interestingly, reserve movements were quite strong in a number of oil-importing countries with fixed exchange rates during this period (Burkina Faso, Cote d’Ivoire, Namibia, and Senegal), some of which were likely associated with large IMF disbursements. Since mid-2009, reserves have recovered in a number of countries.

Reserve changes were not only influenced by a deterioration in the current account but also by the amount available before the crisis. Countries with large reserve buffers used these to cushion the effects of the crisis whereas countries with very low reserves (Ethiopia and Seychelles) needed to build up financing buffers.

Countries with floating exchange rate regimes have been associated with higher inflation during the recent crisis but the ability to adjust the nominal exchange rate has facilitated less volatility in current account and reserve movements compared with fixers. Although the reduction in the growth rate during the crisis was comparable for the floaters and fixers, the former enjoyed higher levels of growth both before and during the crisis.

Constraints on Monetary Policy Effectiveness

Sub-Saharan Africa is characterized by a number of factors that constrain its monetary policy effectiveness. These impediments include reserve levels that exceed required levels in many countries, significant central bank financing of fiscal deficits, weak financial systems in general, and underdeveloped financial markets. However, in recent years, some of these impediments have become less binding, thereby enhancing the effectiveness of monetary policy.

Excess Reserves

One factor that may limit the effectiveness of the monetary policy transmission mechanism is the level of excess reserves in the banking system. A number of countries have used reserve requirements to influence the monetary policy stance but if the level of excess reserves is far beyond this benchmark, the potency of this monetary policy measure is diluted. Saxegaard (2006) has documented a secular increase in reserve requirements over time among African countries, arguing that this change reflects an increased focus on stabilizing inflation coupled with a lack of open-market monetary policy instruments. Since 2007, excess reserves have declined in most countries (Figure 2.12). Indeed, a few non-oil floaters have reduced reserve requirements (Kenya and Mozambique) in response to the scarcity of liquidity during the global crisis and, among this group, excess reserves in percent of deposits are currently about 6 percent, arguably a level in which monetary policy can be effective (see the discussion of private sector credit).

Figure 2.12.Sub-Saharan Africa: Excess Reserves and Reserves Requirements

Sources: IMF, International Financial Statistics; and IMF, Monetary and Capital Markets department database.

Central Bank Financing of Fiscal Deficits

High fiscal deficits can also interfere with the operation of monetary policy by making monetary policy subordinate to the concerns of fiscal policy (fiscal dominant regime). In recent years, monetary authorities’ net claims on government as a share of reserve money have been growing in sub-Saharan Africa, reflecting rising fiscal deficits financed by central banks, in part as donor disbursements fell short of budget commitments (Figure 2.13).6 If this trend continues, and if it creates high-powered money in excess of its demand, it could increase inflation expectations and make stabilization more difficult and costly. The government can also finance fiscal deficits by selling its securities to deposit banks. For non-oil floating rate countries, changes in public sector credit of deposit banks have had a striking negative relationship with their credit to the private sector. During the global financial crisis, the negative relationship could partly reflect crowding out of private borrowing as banks reduced their exposure to risky loans. However, the relationship has also held tightly over the past decade.

Figure 2.13.Sub-Saharan Africa: Monetary Indicators

Sources: IMF, International Financial Statistics; and IMF staff estimates.

Private sector credit is influenced by excess reserves and fiscal policy (see panel regression in Table 2.2). Real private sector credit is significantly related to real interest rates and money growth but the responsiveness to monetary policy instruments is considerably stronger for countries with low excess reserves. This is consistent with greater monetary policy effectiveness when excess reserves are low, although the relationship may also reflect a more developed financial sector.7 The flipside for countries with high excess reserves is that monetary authorities may have particular difficulty stimulating credit growth during a downturn (monetary policy “pushing on a string”). For the subset of countries with low reserves, private sector credit is crowded out through higher government borrowing from the bank and non-bank systems. Changes in commodity price terms of trade also play an important role in the full sample, substituting for other forms of liquidity in the economy. For countries with low excess reserves, during 2007–09, the combination of the 2 percentage point reduction in the real LIBOR rate and the 1 percent decline in the domestic lending rate helped sustain a 7 percent increase in real private sector credit. However, this was offset by a 4 percent of GDP deterioration in the fiscal balance that lowered real private credit by 4 percent, with a slight increase as a net effect.

Table 2.2.Change in Real Private Credit
Full SampleCountries with Low Excess

Real lending rate (t-1)-0.80 ***-1.56 ***-1.64 ***
Change in real money supply (t-1)1.91 ***3.21 ***3.25 ***
Change in fiscal balance-to-GDP ratio- *
Change in real government credit (t-1)-0.06-0.30 *-0.32 **
Change in real LIBOR interest rate-1.31-2.83 *-2.90 *
Change in commodity price terms of trade0.22 ***-0.02-0.01
VIX index (log)-0.01-0.06-0.07
Real GDP growth0.91 *0.51
Private credit to GDP ratio (t-1)-1.08 ***-0.96 ***-0.93 ***
DW statistic1.972.382.42
Countries (number)2199
Sources: IMF, International Financial Statistics; and IMF staff estimates.Note: *** 1% significance; ** 5% significance; * 10% significance.
Sources: IMF, International Financial Statistics; and IMF staff estimates.Note: *** 1% significance; ** 5% significance; * 10% significance.

Weak Financial Systems

When financial systems are under stress, the propagation of monetary policy may be curtailed. For instance, banks may respond to an injection of liquidity by accumulating additional excess reserves rather than extending loans, as they try to rebuild their liquidity and capital buffers. If the economic environment entails greater risk, banks may be reluctant to reduce interest rates or increase lending given the higher risk of default. In addition, concerns about poor asset quality of existing loans may lead banks to be cautious in making new loans. They may keep their portfolio in government securities or reserves at the central bank instead.

Recent developments point to such weaknesses. Based on the 30 countries for which data on both credit growth and NPLs in 2008 were available, the 15 countries with the lowest NPLs also had the highest growth of credit to the private sector (Figure 2.14). This suggests that a strong banking system is needed to generate funding for private sector activity although reverse causality may also be at work if NPLs are projected to rise. Likewise, for the 22 countries with data on both NPLs and excess reserves, the 11 countries with the lowest NPLs also held the lowest excess reserves.

Figure 2.14.NPLs, Excess Reserves, and Credit Growth

Sources: IMF, International Financial Statistics; and IMF, African and Monetary and Capital Markets departmental databases.

Underdeveloped Financial Markets

The effective transmission of monetary policy to the economy relies on well functioning financial institutions and markets. Indeed, across countries, financial depth in banking sector assets and liabilities and the development of financial markets (stocks, bonds, insurance) are associated with a stronger link between central bank policy and deposit bank interest rates (Box 2.4). In many countries in sub-Saharan Africa, the financial sector is underdeveloped with some financial markets absent, and these characteristics can lead to high risk premiums. These factors reduce the impact of policy interest rate changes on economic aggregates and constrain the ability of monetary authorities to conduct appropriate policy.

In spite of these drawbacks, sub-Saharan Africa has a higher interest rate transmission than the average across other countries of the world.

Box 2.4.Financial Development and Other Factors Affecting Monetary Transmission

Using a database on financial development and structure (Beck and others, 2008), the involvement of financial development and other factors in strengthening transmission channels can be investigated. The table shows results from a panel version of the relationships in Box 2, using monthly international data from 1995 (as available). For each bivariate regression, a measure of financial development (or other variable) interacts with the independent variable:

The table shows the marginal long-run effects on the interaction term. Higher incomes (measured from low-income = 1 to OECD = 5) and variables gauging greater development of the financial system are associated with stronger responses of the lending and deposit rates to changes in the discount rate (columns 1 and 2), but are negatively associated with the link from reserve money growth to broad money growth (column 3).

xDiscount RateReserve Money
yLending RateDeposit RateBroad Money
Interaction variable:
Income group0.070.08-0.11
Sub-Saharan Africa0.160.180.10
Oil exporters0.450.010.25
Oil importers fixed0.10-0.080.04
Oil importers floating-
Deposit banks’ reserves (percent of liabilities)-0.34-0.52-0.01
Deposit banks’ assets (percent of total bank securities)0.440.05-0.74
Other financial institutions’ assets (percent of GDP)0.700.99-0.10
Deposit banks’ private sector credit (percent of GDP)0.020.22-0.24
Stock market capitalization0.080.15-0.07
Private bond market capitalization0.400.32-0.04
Life insurance premium volume2.856.31-2.67
International debt issues1.910.43-0.05
Net loans from nonresident banks (percent of GDP)-7.19-6.60-0.61
Offshore bank deposits (percent of domestic bank deposits)-0.43-0.340.00
Fiscal balance (percent of GDP)
Current account balance (percent of GDP)
Source: Beck and others (2008); Financial Development Database; and IMF staff estimates.
Source: Beck and others (2008); Financial Development Database; and IMF staff estimates.

Interestingly, the interest rate links are stronger for sub-Saharan Africa than for the average country in the panel, which includes many other emerging and developing countries in addition to advanced countries. Deposit bank reserves held at the central bank, loans from nonresident banks, and offshore deposits tend to weaken the link from the policy rate to market rates, as does higher concentration in the domestic banking system. Remittances weaken the link to the lending rate but slightly increase the link to the deposit rate. A higher ratio of deposit bank reserves relative to their liquid liabilities is associated with a much weaker interest rate link. Lastly, the interest rate link is also stronger when the fiscal and current account balances improve, although the relationship is small in magnitude.

This box was prepared by Valerie Cerra.

Looking Forward

Economies of sub-Saharan Africa are regularly buffeted by severe external shocks, requiring macroeconomic tools for stabilization. Monetary policy can play a role in adjustment, particularly as fiscal positions become strained and geared toward other purposes. In some countries, central banks could more actively use their monetary policy instruments. The scope is greatest for countries with floating exchange rates or for a few fixed exchange rate countries with limited capital mobility. But even for countries in which policy rates are set exogenously (members of currency union or fixed exchange rate countries passively tied to global interest rates), the evidence suggests that these passive changes in policy instruments have significant transmission to the banking sector and domestic economy. Nonetheless, given the size of shocks, monetary policy is far from fully effective and will need to be complemented by supportive structural policies and safety nets.

Measures to speed the identification and reaction to changes in economic conditions would improve policymaking. These measures could include enhancing the quality and timeliness of statistical data and developing simple models of inflation dynamics. As central banks enhance their analytical capacity, they could also strengthen research on monetary transmission in their countries and build econometric and structural models to explore the best mix of instruments and the magnitude of the policy response.

Countries with floating exchange rate regimes have used the flexibility to dampen the impact of external shocks on their current accounts.

For countries choosing limited exchange rate flexibility, it is particularly important to have other types of buffers, such as sufficient foreign exchange reserves and fiscal flexibility, for adjusting to adverse external conditions.

Institutional and technical developments could improve the execution and effectiveness of monetary policy in the region. Reforms and development should include:

  • Developing deeper and more competitive financial markets so that changes in policy instruments will transmit to market interest rates and credit to the private sector.
  • Improving banking sector soundness, by modernizing the regulatory environment and improving financial supervision, so that the financial sector has the capacity to lend and will appropriately allocate scarce savings to the most efficient use while prudently managing risk.
  • Restoring fiscal sustainability and low deficits, so that monetary policy can perform its stabilization function rather than financing fiscal shortfalls.
  • Improving institutions, including central bank independence, accountability, and transparency, as well as broader market infrastructure such as credit reference bureaus, land cadastres, and legal enforcement of contracts.
  • Building resilience to shocks through the policies discussed above and through economic diversification.

This chapter was prepared by Valerie Cerra, Robert Keyfitz, Taufik Rajih, Alun Thomas, with contributions from Gustavo Ramirez and Duval Guimarães.


To some extent, it is still on the early side to provide a comprehensive answer to this question because monetary policy operates with a lag and policy actions from 2008–09 may still be playing out. In addition, output growth data are not final for some countries. Consequently, we proceed by estimating the monetary transmission mechanism using data from the past decade or more to gauge the likely impact of recent policy actions.


Mishra, Montiel, and Spilimbergo (2010) find that the long-run linkage between movements in discount rates and money market rates is weaker in LICs than among advanced and emerging countries. Since this chapter looks at linkages between the discount rate and the lending rate, the difference in results may relate to the behavior of money market rates. Indeed, Mishra and others find that the relationship between money market and lending rates is comparable across country groups.


The inclusion of global oil and food price variables in the VAR controls for these effects to some extent, but perhaps not for other supply shocks.


To check for robustness, we also looked at the period 2007–09 and fixers and floaters separately. Reserve money growth shocks have a greater impact on growth, inflation, and exchange rate depreciation over the recent period. Shocks to the discount rate have less impact on the lending rate, but marginally more impact on growth. Policy interest rate changes have little effect on growth for fixers whereas reserve money growth shocks have a longer lasting impact on growth relative to floaters.


Not surprisingly, because except for Nigeria, all of the other oil-exporters have fixed exchange rate regimes.


Baldini and Poplawski-Ribeiro (2008) give evidence of the relative importance of fiscal and monetary determinants of inflation in sub-Saharan Africa, and show that a number of countries were characterized by chronic fiscal dominant regimes during 1980–2005.


Countries with low excess reserves are those with excess reserve levels that are below 10 percent and include Gambia, Ghana, Kenya, Lesotho, Malawi, Mauritius, Mozambique, South Africa, Tanzania, and Uganda; the median estimate of the low excess reserves sample is 4.1 percent.

    Other Resources Citing This Publication