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Prepared by Shanaka J. Peiris
Alternatively, it could peg its exchange rate to another country’s currency, but this option is not pursued here since Uganda’s floating exchange rate regime is deemed to have served it well and a regime switch is not under consideration.
Moreover, the Central Bank would require a liquid market in the target instrument that is not dominated by its own operations, which is not the case in Uganda given the limited activity of the interbank and other securities markets.
External grants and loans, which are credited to the BOU’s foreign correspondent bank accounts, have no domestic liquidity impact until they are drawn down and spent domestically by the government. A lower fiscal deficit due to higher taxes or lower expenditures due to less external financing would reduce the amount of liquidity injected.
In addition, the BOU also uses repos for fine-tuning ‘temporary’ liquidity variations, although there have been a greater reliance repos for sterilizing structural liquidity as of late.
Sales of foreign exchange could be used as a tool of sterilization only to a point until the foreign exchange reserve target becomes binding, which is not presently the case in Uganda.
A structural VAR model was not attempted given the purpose of the paper and the lack of a rich array of reliable high-frequency macroeconomic data (e.g., productivity).
The Cholesky decomposition imposes the correct number of restrictions for just identification and imposes a recursive structure on the system; so that the most endogenous variable is ordered last, i.e., it is affected by all contemporaneous ‘structural’ shocks. The results of the VAR thus could be highly susceptible to the ordering chosen.
The system does not, however, encompass New Keynesian Phillips curve specifications, which are based on firm microfoundations, and is a weakness in the approach taken. See Gali and Gertler (1999) for such a framework.
Food and foodstuff have a 27.4 percent weight on the CPI basket, based on the living standard survey of 1997/98.
However, first differencing may lead to the loss of information on the long-run relationships between the variables, which is a weakness in the approach.
The VAR is estimated from June 1993 to June 2004 on a monthly basis in log differences, with the lag length determined by Akaike information criteria.
This may be explained by the greater share of nontradable goods in core inflation.
An estimation of a money demand function with more recent data also suggested a money demand function with an income elasticity of unity and the presence of a clearly identifiable single structural break.
Exchange rate and interest rate volatility are also often quoted as potential determinants of economic performance in the short term, but the inclusion of ‘volatility’ indicators such as standard deviations and forecasts of Generalized Autoregressive Conditional Heteroskedastic (GARCH, 1,1) models did not show significant effects, and thus are excluded from the empirical framework. In this sense, the results for Uganda differ from Adam (2001).
The contrasting determinants of industrial production and exports are compatible given the very small share of manufacturing in total exports.