Financial Strength of the Central Bank and Monetary Policy Outcomes in Common Market for Eastern and Southern Africa Region
Muthua, Laban Kimanja
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The Common Market for Eastern and Southern Africa monetary union co-operation programme was signed in 2005 by member countries and was aimed at establishing a regional Monetary Union by the year 2018. The set convergence criteria were aimed at removing macroeconomic disharmonies as a result of pursuing different economic policies by member states. The convergence criteria set include; achieve inflation target of three percent and also achieve and maintain stable exchange rates and interest rates amongst others. From monetary economics, central banks are modelled more often than not as maximizers of some objectives which include promoting stability of prices amongst other objectives. However, this viewpoint disregards the point that central bank tasks are inevitably deployed on its balance sheet and therefore affect the financial strength of the central bank. Weak central banks finances have brought to the fore the issue of financial ability of a central bank and whether a central bank is able to conduct monetary policy optimally and achieve its mandate of policy formulation. The average central bank financial strength in the region over the study period stood at 0.03, which was considered weak when compared with other regions such as European Union. The set convergence criteria were largely not achieved over the study period; average annual inflation rate stood at nine percent, exchange rate volatility and interest rate volatility stood at 25.5 and 1.05 respectively which was high when compared to other regions. This study therefore sought to empirically analyse central bank financial strength and how it affects key monetary policy outcomes namely; price stability, interest rate variability and exchange rate variability in the Common Market for Eastern and Southern Africa region using secondary country level data covering the period 2001 to 2017. Empirical studies are not conclusive on the effect of central bank financial ability on monetary policy outcomes and asserts that the relationships depends on the country or region unique characteristic, no study have been conducted in the region. The study was anchored on the theory of central bank financial strength which asserts that if the central bank financial ability, in terms of its finance, and preference are consistent, then the response of central bank will be consistent with the direction of the goals. General Method of Moment estimation technique was used to estimate the dynamic panel data regression model. Empirical results showed that inflation is inversely related to central bank financial strength. The results further indicated an inverse relationship between central bank financial strength and interest rate variability. However, the results showed that central bank financial strength has no effect on exchange rate variability. The Monetary Affairs Committee of Common Market for Eastern and Southern Africa region should consider including central bank financial strength as one of the convergence criteria, which this study has established affects monetary policy outcomes in the region. Further, the national treasuries of Common Market for Eastern and Southern Africa member countries, who are the central banks shareholders, should ensure the financial strength of central banks in Common Market for Eastern and Southern Africa region is enhanced due to its effects on monetary policy outcomes.