Impact of monetary policy rate on money supply in Zambia (2012-2020).

Money supply is one of the key variable any monetary policy framework aims at influencing. Central banks all over the world have several instruments at their disposal to control the supply of money in their economies and one such instrument is the monetary policy rate. This study provides an analysis of the impact of monetary policy rate on money supply in Zambia. Quarterly time series data for monetary policy rate, money supply-2, lending rate and exchange rate covering the period from second quarter 2012 to fourth quarter 2020 was used. The study focused on channels through which monetary policy rate directly and indirectly affects money supply. Vector Autoregression (VAR) and the Autoregressive Distributed Lag (ARDL) approach were used to analyse the indirect and direct impact of monetary policy rate on money supply respectively. Empirical results revealed that monetary policy rate has a significant positive impact on lending rate in the short run only. Its impact on lending rate is weak as after 8 quarters, only 21 percent of the variations in lending rate is attributed to monetary policy rate while 79 percent is explained by own shocks in lending rate. With regards to exchange rate, the results showed the absence of pass-through effect from monetary policy rate to exchange rate. In the short run, monetary policy rate has no impact on money supply while exchange rate has both positive (i.e. wealth effect) and negative (i.e. currency substitution effect) impacts, with positive impact outweighing the negative impact. In the long run, both monetary policy rate and exchange rate have significant effect on money supply with a positive elasticity attributed to exchange rate being greater than the negative elasticity attributed to monetary policy rate in absolute terms. These elasticities have far reaching implications on the effectiveness of monetary policy rate on money supply as its impact is overshadowed by the exchange rate wealth effect. In view of the aforementioned, to improve the effectiveness of monetary policy rate, policies that ensure competition in the banking sector and stability of exchange rate should be strengthened.
Keywords: Policy Rate, Exchange Rate Pass-through effect, Structural break, ECM, Impulse Response