Monetary Policy and Inflation in Zambia

Patricia Funjika1, Chewe Mwila and Patrick Mulenga

Abstract
This study investigates the effectiveness of monetary policy in Zambia
since the transitioning to inflation targeting in April 2012. Using
quarterly data from 2012 to 2022, we find evidence of cointegration
among endogenous variables and estimate a structural cointegrated
vector error correction model which adjusts for existing long-run
relations among variables, based on economic theory, and incorporates
exogenous variables. Impulse response functions results suggest that
monetary policy transmission is generally effective, though a hike in the
policy rate starts slowing down inflation after a lag of two quarters. We
observe a sharp decline in inflation after a year with the effects
dissipating after seven quarters. The findings reinforce the argument
that monetary policy effects are not contemporaneous. The model set up
suggests that analysis of monetary policy effects can be improved by
incorporating domestic supply-side factors as well as external variables.
JEL Classification: C50, E52
Keywords: Zambia, monetary policy, inflation, structural
cointegrated vector autoregressive model, VECX*

1. INTRODUCTION
Global inflation has been on the rise since the onset of the COVID-19 pandemic in late 2019
due to a myriad of factors stemming from supply chain disruptions, labour shortages, surging
commodity prices and a change in consumption patterns. In 2022, world consumer prices
are expected to rise by 8.8 percent, the highest since 2008, driven by higher commodity
prices and persistent supply-side constraints in many sectors, which have been exacerbated
by the Russia-Ukraine conflict (Ha et al., 2021; International Monetary Fund, 2022).
Emerging markets face higher consumer prices at 9.9 percent, posing a risk to economic
recovery post the COVID-19 pandemic (International Monetary Fund, 2022). Sustained price
increases have several negative effects, including undermining the role of money as a
medium of exchange by acting as a tax on cash holdings; increasing the cost of borrowing;

1Corresponding author: pfunjika@[Link]. Bank of Zambia, P.O. Box 30080, Lusaka, 10101. Zambia. The study
benefitted from comments received from the Technical Committee discussions held with Bank of Zambia staff.
The findings and opinions expressed in this paper are entirely those of the authors and do not in any way
represent the views or position of the Bank of Zambia. The authors remain responsible for all the errors and
omissions.
driving uncertainty about relative prices and the future price level. This makes it difficult for
firms and individuals to make appropriate decisions and ultimately leads to decreased
economic efficiency; and if unanticipated, wealth and income redistribution that may be
detrimental for certain individuals and sectors of the economy and may further undermine
confidence in property rights (Lucas Jr, 1972; Fischer, 1984; Briault, 1995; Mishkin, 2011).
As such, inflation is an important variable of interest in the conduct of monetary policy by
many central banks.
Most central banks have set price stability as the primary objective of monetary policy to
support economic growth and foster job creation and prosperity. To achieve this objective,
monetary authorities have at their disposal different sets of monetary policy instruments
whose use is guided by the adopted monetary policy framework. In this regard and as part
of the modernization process of its monetary policy, the Bank of Zambia (BoZ) shifted to an
inflation targeting (IT) regime in April 2012, marking the end of the monetary aggregate
targeting (MAT) framework which had been in existence since 1991. The IT regime uses the
monetary policy rate (MPR) as its main instrument to control inflation. Under this new
framework, the primary objective of price stability entails achieving inflation within a target
band of 6-8 percent. The shift to inflation targeting was informed by empirical work, which
revealed that monetary aggregate targeting was no longer effective as the relationship
between broad money and inflation had weakened (Zgambo and Chileshe, 2014). This was
compounded by the uncertain stability of the money multiplier. Further arguments in favour
of inflation targeting include claims that the framework improves market participants'
understanding of the monetary policy stance, strengthens the interest rate channel of the
monetary policy transmission mechanism, reduces interest rate volatility, provides an
anchor for market expectations regarding interest rates and inflation and promotes clarity
on how banks set lending rates by making the policy rate explicit (Zgambo and Chileshe,
2014). Bernanke and Mishkin (1997) also cite the importance of policy coherence where
even "discretionary" monetary policy actions can be accommodated as an additional
advantage of the inflation targeting framework.
Various shortcomings of the inflation targeting framework have also been highlighted in the
literature. These include views that the framework is rigid, allows for excessive discretion,
might increase instability in output and can result in lower economic growth (Mishkin, 1999;
Bernanke et al., 2018). For emerging markets, the inability to prevent fiscal dominance, as
well as the possibility that exchange rate flexibility needed by inflation targeting may
produce financial instability are also major concerns (Mishkin, 2000). Of interest in this
paper is a key disadvantage of inflation targeting for developing countries as discussed by
Mishkin (2002) that relates to the lengthy lags in the transmission process from the
monetary policy instrument to the inflation outcome which may result in weak central bank
accountability. Given that inflation outcomes that include the effects of changes in
instrument settings are visible only after a significant lag, in episodes of high inflation where
inflation forecast errors are usually substantial, the targets may be missed raising credibility
concerns about the central bank's inflation policy. To mediate expectations, it is important
to provide evidence that indicates the timing or temporal effect of a monetary policy
decision. Therefore, the objectives of this paper are to evaluate the effectiveness of monetary
policy since the implementation of the inflation targeting regime in 2012 and to present
evidence on how long it takes for monetary policy adjustments to affect inflation.

Several studies have been conducted on the effectiveness of monetary policy within the
domain of monetary economics. The studies provide contradictory evidence from the
different country experiences. Ahiabor (2013) and Moki (2014) find weak monetary
transmission effectiveness in Ghana and Kenya, while for South Africa and Nigeria, de Waal
and van Eyden (2014) and Onwachukwu (2014) identify effective monetary policy. The
differences in effectiveness can be attributed to the level of economic and financial structures
in existence within a country which determine the efficacy of the transmission process
(Montiel, 2013). Rasche and Williams (2005) compare monetary policy effectiveness in
inflation targeting regimes among various countries, the majority of which are developed
economies, and find that central banks that adopt this approach are able to achieve the
inflation target in the medium term. However, a caveat to their findings is that the marginal
contribution of the regime beyond providing a credible commitment to price stability is
unclear, and the behaviour of inflation when there are large economic shocks cannot be
ascertained. There are few studies on the broad subject area in Zambia, with the closest being
research work by Haabazoka and Nanchengwa (2016) who find the policy rate ineffective in
managing inflation bringing into question the reliability of the current monetary policy
approach. We contend that, given the limited data employed in their research and structural
flaws in their methodological approach which does not take into account endogeneity of the
variables included in their model, there is still a gap in understanding the effectiveness of
monetary policy.

This paper offers two main contributions. First, we provide new empirical results on the
effects of endogenous monetary policy on inflation within a model that accounts for the
inclusion of exogenous variables and show that the monetary policy rate is an effective
nominal anchor for the containment of inflation. Thus, we show that changes in monetary
policy slowdowns inflation after two quarters and results in a steep decline in the rate of
inflation after a year, with the effects dissipating after seven quarters. Second, we also show
that accounting for the effect of exogenous factors on the Zambian economy provides better
estimates of monetary policy and supports the argument that modelling of small open
economies should account for exogenous variables. In our counterfactual analysis, we find
that the inclusion of a fiscal policy variable augments the effectiveness of monetary policy in
controlling inflation during the first year implying that fiscal policy is complementary during
this period.

The rest of the paper is organized as follows: In the next section, we provide background
information on the evolution of monetary policy in Zambia from the pre-liberalization period
to the switch to inflation targeting and provides more information on the current policy
framework. The transmission mechanism of monetary policy is also discussed, highlighting
the various channels through which changes to the policy stance affect inflation. Section 3
presents a brief literature review with focus on empirical studies that relate monetary policy
to inflation. The methodology and long-run relationships are discussed in sections 4 and 5,
respectively. The results from the structural vector error correction model are set out in
section 6. Section 7 concludes and offers policy implications and areas for future research.
2. EVOLUTION OF MONETARY POLICY IN ZAMBIA
This section provides a summary of the evolution of monetary policy in Zambia from pre-
liberalization when monetary aggregates were used to the current inflation targeting period.
Prior to economic liberalization in the early 1990s, monetary policy mainly relied on the use
of direct instruments, such as, interest rate controls, directed credit allocation as well as core
liquid assets and statutory reserve ratios (Kalyalya, 2001). However, due to lack of clear-cut
monetary policy focus, macroeconomic conditions began to worsen gradually during the
period prior to the 1990s. This was largely attributed to the continued use of the central bank
to finance fiscal deficits as well as the inability of the monetary authority to control money
supply leading to higher inflation.
Domestically, price controls on most food items, widespread consumer subsidies, weak
public administration and worsening fiscal position led to internal imbalances. On the
external front, imbalances stemmed from the unsustainable balance of payments position
due to growing foreign debt servicing compounded by the reduction in international
reserves and diminishing export earnings as both copper prices and production volumes
declined. This led to stagflation.
Annual economic growth contracted by an average of 1.1 percent during the 1981-90 period
from an expansion of 3.9 percent during 1961-65 period. In the same period, external debt
as a percentage of gross domestic product (GDP) surged to 119 percent from 49 percent
(Zambia Statistics Agency, 2022). In addition, inflation reached an average of 76.9 percent
during the 1980s, and with negative real interest rates, the banking system began to lose its
role of intermediation and credit to the private sector fell relative to GDP (Zgambo and
Chileshe, 2014).
The challenges experienced before liberalization led to a shift in the economic landscape in
1991 as the new government embarked on a plan to re-establish economic growth through
a series of economic reforms and policies aimed at creating a market-based economic system
driven by the private sector. By way of economic reforms, market forces were granted a
greater role in the allocation of resources as prices were decontrolled and most subsidies
eliminated. Other measures taken include the liberalization of the foreign exchange market
via the removal of exchange controls and the decontrolling of interest rates (Kalyalya, 2001).
This wind of change in the economic reforms was further extended to the conduct of
monetary policy, which was further enhanced by the amendment of the Bank of Zambia
(BoZ) Act in 1996 that pinpointed the central bank’s objective to price and financial system
stability. Following this development, the Bank was empowered to pursue appropriate
monetary policy in support of sustainable economic growth (Zgambo and Chileshe, 2014).
The inflation target was to be set by the Ministry of Finance (MoF) in consultation with the
Bank of Zambia. With the inflation target set by the MoF, BoZ had the discretion to use
monetary policy instruments at its disposal in managing liquidity conditions with the aim of
achieving the inflation target. Under the new framework, BoZ started to target monetary
aggregates, an approach premised on a strong and stable relationship between the ultimate
target (inflation) and money supply.
The change in the monetary policy framework and its implementation contributed to a
notable improvement in the macroeconomic environment. Money growth and inflation
declined sharply, and the latter was held in the single digits since 2006. The liberalization of
lending and deposit rates initially caused real interest rates to spike, but later stabilized
around 5 percent (Kalyalya, 2001). In addition, real GDP growth steadily improved to an
average of 6.6 percent during the period 2001 to 2012 from 0.8 percent between 1991 and
2000 (Zambia Statistics Agency, 2022; Zgambo and Chileshe, 2014).
A review of the money multiplier for Zambia by Zgambo and Chileshe (2014) suggested that
it was not particularly stable during the period of the MAT framework. Before 2000, the
economy was characterized by general instability with relatively high growth rates in money
supply and elevated inflation rates partly reflected in the instability of the money multiplier.
However, for the period 2001-2007, the money multiplier exhibited some relative stability.
From 2008 to the end of February 2014, the stability of the money multiplier appeared to
have been unclear. In addition, the lower correlation coefficient between broad money
growth and inflation of 0.52 in the post-1995 era than 0.7 in the pre-1995 period suggested
a weakening relationship between the two variables. Given that successful implementation
of monetary policy under the MAT framework requires a strong relationship between money
supply growth and inflation, this outturn presented a challenge and suggested that the
framework had become a less reliable indicator of the future evolution in inflation. The weak
relationship between broad money and inflation combined with the questionable stability of
the money multiplier led to a rethink of the monetary policy framework and prompted the
Bank of Zambia to transition to an inflation targeting monetary policy framework in April
2012 (Zgambo and Chileshe, 2014).
According to Zgambo and Chileshe (2014), the introduction of the policy rate was
necessitated by the need to enhance market participants’ understanding of the monetary
policy stance and strengthen the interest rate channel of the monetary policy transmission
mechanism. Other factors were the need to reduce interest rate volatility that tends to
characterize MAT frameworks, anchor market expectations with regard to interest rates and
inflation and promote transparency in the way banks set lending rates by making the MPR a
reference rate for the pricing of credit products.
In this regard, the impact of the MPR on key macroeconomic variables such as inflation and
output becomes vital not only in the context of the direction as noted by Bain and Howells
(2009) but also from a perspective of the time lag between a change in the official interest
rate and its impact on aggregate output and inflation, as well as the magnitude of the impact
(Mishkin, 1995; de Waal and van Eyden, 2014). Thus, the effectiveness of monetary policy in
controlling inflation implies the direction and size of impact on inflation as well as the speed
with which inflation responds to changes in the monetary policy rate (monetary policy
shocks).
In terms of transmission, the categorization proposed by Mishkin (2007) can be used to
summarize the conventional interest rate channel and the exchange rate channel of the
monetary policy transmission mechanism. According to the conventional interest rate
channel, monetary expansion (a reduction in the policy rate) will result in a decline in all
other interest rates. Lower interest rates will boost fixed investment and consumption and
consequently, real output will rise and lead to higher inflationary pressures. The
expansionary monetary policy will reduce domestic interest rates relative to international
interest rates according to the exchange rate channel. This will in turn lead to capital
outflows causing the domestic currency to depreciate. Subsequently, net exports and real
output will increase and ultimately lead to higher inflationary pressures.

In the case of Zambia, the policy rate signals the stance of monetary policy and provides a
credible and stable anchor to financial market participants in setting their interest rates.
More specifically, commercial banks use the policy rate as the base rate when setting interest
rates for their loans and advances (Bank of Zambia, 2015). The MPR also guides open market
operations (OMOs) and is expected to influence the lending rate in the overnight interbank
market. The interbank rate, being a price at which banks lend to each other, is anticipated to
impact retail interest rates set by commercial banks and in turn demand for credit, aggregate
demand and ultimately inflation.
Increases in the MPR are interpreted as contractionary in nature as they make the cost of
credit high, constrain aggregate demand and moderate inflationary pressures. In contrast,
cuts to the MPR are viewed as expansionary as they result in lower cost of credit, stimulate
aggregate demand and lead to a build-up in inflationary pressures. Since its inception in April
2012, the impact of the MPR on inflation is not clear as it has had mixed influence as shown
in Figure 1. For instance, initially, inflation remained in single digits following the switch to
inflation targeting until October 2015 when it rose to 14.3 percent from 7.7 percent a month
prior. This prompted the Bank of Zambia to hike the MPR to 15.5 percent in November 2015
from 12.5 percent. Nonetheless, inflation rose to as high as 22.9 percent in February 2016
and remained in double digits until November in the same year. A similar phenomenon was
observed between September 2019 and April 2020 when inflation was rising despite the
tight monetary policy stance. It is against this background that this study seeks to examine
the effectiveness of monetary policy in controlling inflation in Zambia for the period April
2012 to March 2022.
Figure 1: Monetary Policy Rate and Inflation

Source: Authors computation from Bank of Zambia (2022), Zambia Statistics Agency (2022)
3. LITERATURE REVIEW

The literature on the relationship between monetary policy and inflation is expansive in both
theory and cross-country as well as country-specific studies. In this paper, we focus largely
on empirical studies that are closely aligned with our objectives. The full literature review
matrix providing details on research works cited in this section is presented in Table B.1. By
focusing on the relationship between monetary policy and inflation, we contribute to three
main strands of literature. Firstly, we contribute to studies that have sought to understand
the effectiveness of monetary policy. Seminal work on this was provided by Friedman (1961)
who argued that monetary policy was effective in leading to changes in economic conditions
though only after a sizeable lag that was both long and varied. Rasche and Williams (2005)
reviewed the changing views of the role and effectiveness of monetary policy and analyzed
inflation targeting as an effective monetary policy framework. Their findings showed high
volatility in annualized inflation within countries that had explicit numeric targets. However,
use of the moving average measure indicated effective monetary policy in some of the
countries. Mishkin (2009) discussed monetary policy effectiveness during financial crises,
arguing for more aggressive monetary policy during these episodes to reduce the likelihood
of adverse feedback loops. The level of financial development was also found to be a critical
factor, with the effectiveness of monetary policy on output declining as the financial system
becomes more developed while the effect on inflation increased in advanced economies (Ma
and Lin, 2016).

Other empirical studies have examined the effectiveness of monetary policy with varying
results. They generally find that monetary policy transmission mechanism is effective
though the channel varies from monetary aggregate to interest rates (Bhattacharya and Jain,
2020; Haabazoka and Nanchengwa, 2016; Igbafe, 2022; Moki, 2014; Mwafulirwa, 2017;
Rasche and Williams, 2005; Zgambo and Chileshe, 2014).

Various studies have also focused on the impact of monetary policy on inflation. For instance,
Ahiabor (2013), Angelina and Nugraha (2020), Iddrisu and Alagidede (2020), Miyajima
(2021), Okimoto (2019), Onwachukwu (2014), and Ribon (2011) examined the impact of the
monetary policy strategy adopted in respective countries on inflation and found a positive
and significant relation between the two variables. Bhattacharya (2014), Mishra and Montiel
(2013) and Patrick and Akanbi (2017) analysed the monetary policy transmission
mechanism and provided evidence on the effective channels of transmission as well as the
timing effect of various shocks on inflation.

Nonetheless, scant literature exists empirically on the broad subject matter in Zambia. Most
inflation studies in Zambia have focused on the determinants of inflation and monetary
policy transmission mechanism. To the best of our knowledge, there are few studies that
have gone further and empirically examined the effectiveness of monetary policy in Zambia
(Zgambo and Chileshe, 2014; Mwafulirwa, 2017; Haabazoka and Nanchengwa, 2016).
Zgambo and Chileshe (2014) found that monetary aggregates (broad money) and the
exchange rate were important variables for monetary policy transmission. In contrast to
Hangoma (2010), they found that interest rates had no significant effects on output and
prices. Mwafulirwa (2017) estimated the monetary response functions for the Zambian
economy based on the policy rate and money supply. She found that money supply was more
responsive to inflation gap than the policy rate and concluded that money supply was a more
effective policy instrument. Haabazoka and Nanchengwa (2016) also used monthly data
from 2012 to 2014 to assess the effectiveness of the Bank of Zambia policy rate in
maintaining favourable inflation levels and found that the policy rate was ineffective as a
policy tool to manage inflation as any variations in the price level were already explained by
changes in the exchange rates. However, they do not consider possible endogeneity in their
modelling approach which may affect the accuracy of their results. A general feature of
existing studies that use the policy rate as a measure of the effectiveness of monetary policy
is the short duration of the data span, as the policy rate was introduced in 2012, which may
result in biases in their estimations, and the lack of consideration of effects of exogenous
factors, which may be relevant to Zambia as a small open economy. We, therefore, enhance
earlier studies in this area by considering more data points which reflect current trends in
the variables under consideration and including exogenous variables which provide better
insight into the modelling techniques of the effectiveness of monetary policy.

Secondly, we contribute to research works that control for the effects of exogenous variables
within endogenous models, also known as the VECX* models2. This is a methodology that is
yet to be used in the modelling of monetary policy effectiveness in Zambia. This method has
the advantage of accounting for short-run features and long-run theoretical relations both of
which are crucial in analyzing the effects of monetary policy shocks. This method also
enables the inclusion of supply-side shocks and weakly exogenous foreign variables that may
be pertinent to a small open economy like Zambia. Empirical work using this type of model
include those that study the relationship between key macroeconomic variables in
Switzerland (Assenmacher-Wesche and Pesaran, 2008) and construct small macro
econometric models of the United Kingdom (Garratt et al., 2003), Indonesia (Affandi, 2007),
and Thailand (Akusuwan, 2005). It was further applied to understand the transmission of
monetary policy in South Africa by de Waal and van Eyden (2014) who argued that the model
provides a more accurate portrayal of the effectiveness of monetary policy as it incorporates
foreign variables. Given the similarities in terms of openness between Zambia and South
Africa, application of this model provides a more comprehensive account of the effectiveness
of monetary policy.

Thirdly, by including other factors in the endogenous model that impact on inflation, this
study relates to similar works that have concentrated on the determinants of inflation. Most
of the studies on African countries find that monetary aggregates, output and climatic shocks
- and subsequent supply-side deficiencies - are the main determinants of inflation (Chipili,
2022; Mohanty and John, 2015; Nguyen et al., 2017, Adu and Marbuah, 2011; Laryea and
Sumaila, 2001; Moser, 1995). Other non-monetary factors which drive inflation include fiscal
deficits in countries with under-developed government securities markets, degree of central
bank independence, exchange rate regime and degree of price liberalization (Cottarelli,
1998).

2Detailed theoretical expositions on the model are provided in Garratt et al. (2003, 2006) and Pesaran et al.
(2000).
We use existing research works to identify key variables to include in the empirical model
and contribute to this strand by identifying long-run relations and including restrictions on
empirically proven relations that also explain movements in inflation.

4. CONCEPTUAL FRAMEWORK
Given that changes in the monetary policy rate do not directly impact inflation, we identify
various channels of monetary policy transmission based on economic theory and reviewed
literature. These include the interest rate, credit or bank lending, asset prices, exchange rate
and expectations channels (Mishkin, 2007).

Through the interest rate channel, an increase in the MPR is expected to lead to a rise in the
overnight interbank rate (increasing the short-term cost of funds for banks). This results in
higher real long-term market interest rates since banks use the MPR as a benchmark for
pricing their credit products. Consequently, credit demand reduces, aggregate demand
weakens (via lower consumption and investment) and ultimately lowers inflationary
pressures. Of great significance to this channel is the emphasis placed on the real long-term
market interest rates having a major impact on both consumption and investment
expenditure decisions, which in turn determines the extent to which aggregate demand and
inflation are affected (Mishkin, 2007).

The credit or bank lending channel is vital in the transmission mechanism of monetary policy
given the crucial role of financial intermediation played by banks in an economy as they
navigate the problems associated with asymmetric information in credit markets (Mishkin,
2007). Through this channel, tight monetary policy is expected to reduce bank reserves and
bank deposits, which lowers the quantity of bank loans available (limits credit supply).
Subsequently, consumption and investment spending will decrease, aggregate demand will
reduce, and inflationary pressures will reduce. (Mishkin, 2007) opines that this channel
would be more effective in economies with underdeveloped capital markets and many
smaller firms whose major source of investment financing are bank loans. For Zambia, the
capital markets are relatively undeveloped and Ngoma and Chanda (2022) suggest that the
bank lending channel is ineffective due to incomplete and asymmetric pass-through from the
interbank rate to retail interest rates resulting from the existence of imperfections in the
retail market.

The exchange rate channel is one of the primary transmission channels particularly in open
economies with flexible exchange rate regimes (Zgambo and Chileshe, 2014). In this case,
the impact of MPR changes on inflation occurs either through interest rates (uncovered
interest rate parity (UIP)), direct intervention in the foreign exchange market or through
inflation expectations. A change in monetary policy stance affects aggregate demand through
net exports. Under the UIP condition, the differences between domestic and foreign interest
rates on financial assets represents the expected change in exchange rate (Mishkin, 1995).
Thus, an appreciation in the local currency arising from a tight monetary policy stance is
expected to have an impact on both aggregate demand and aggregate supply. On the demand
side, this makes the country’s exports more expensive compared to foreign produced goods
leading to a reduction in net exports, weaker aggregate demand and subsequently, lower
inflationary pressures. On the supply side, a real appreciation of the local currency lowers
the cost of imported goods that directly reduces domestic inflationary pressures through the
exchange rate pass-through. For import-dependent countries like Zambia, the exchange rate
pass-through effect to domestic prices tends to be more pronounced.

The asset price channel focuses on how changes in monetary policy affect inflation through
prices of bonds, equity and real estate, changing firms’ stock market values and household
wealth. This channel operates through the Tobin’s (1969) Q-theory of investment and Ando-
Modigliani life cycle of consumption. In this case, changes in the monetary policy stance are
expected to induce substitution among the various assets. For instance, Afandi (2005) states
that through the Q-theory of investment, a monetary policy rate cut would make economic
agents to substitute bonds for equities (as they become more attractive). This would then
result in increased market value of firms relative to the replacement cost of capital and thus,
lead to higher investment and aggregate demand and ultimately, a rise in inflationary
pressures. However, this channel has been found to be unimportant for monetary policy
transmission in Zambia (Patrick and Akanbi, 2017).

The expectations channel assumes that economic agents are forward looking and rational.
Therefore, expectations about various macroeconomic variables are formed to inform
decision-making in the current period. For instance, if economic agents expect a depreciation
of the local currency, domestic prices are likely to be adjusted upwards. This will lead to
expectations of higher interest rates in the future, increased aggregate demand and elevated
inflationary pressures in the short-term (Mishkin, 2007, Bank of Zambia, 2015).

5. MODEL SPECIFICATION AND ESTIMATION METHOD

The paper closely follows the approach by de Waal and van Eyden (2014) and uses a
structural cointegrated vector autoregressive framework with exogenous variables to model
the relationship between inflation and monetary policy. The model is also referred to as the
VECX* model and is documented in Garratt et al. (2006).3 The vector error correction model,
zt can be expressed as:
𝑝−1
Δ𝑧𝑡 = 𝑎0 + 𝑎1 + ∑𝑖=1 Ω𝑖 Δ𝑧𝑡−𝑖 + Π𝑧𝑡−1 + 𝑒𝑡 𝑡 = 1,2, … (1)

Where the vector of endogenous and exogenous I(1) variables, zt, can be partitioned into zt=
(𝑦𝑡′ , 𝑥𝑡′ ) with yt denoting the vector of endogenous I(1) variables (domestic variables), and xt
p−1
representing the exogenous I(1) variables. The short-run matrix is represented by Ωi=1
while the matrix of long-run coefficients is Π. The intercept and trend matrices are
symbolized by 𝑎0 and 𝑎1 while the error process is defined by 𝑒𝑡 and is assumed to be
𝐼𝑁(0, Ψ), with Ψ positive definite.

3
An exposition of the comparison between structural cointegrated VARs and other standard macro
econometric modelling approaches is discussed in Garatt et. al. (2003). The main advantage of structural
cointegrated VARs highlighted is the ability to embed empirically proven and theory consistent long run
relationships in the model.
Expressing the variables 𝑒𝑡 , 𝑎0 , 𝑎1 , Ω, and Π as partitions of 𝑦𝑡′ and 𝑥𝑡′ in conformity with zt=
(𝑦𝑡′ , 𝑥𝑡′ ), the conditional model for Δ𝑦𝑡 in terms of zt, Δ𝑥𝑡 and the lagged values of zt, is:
𝑝−1
Δ𝑦𝑡 = −Π𝑦 𝑧𝑡−1 + ΛΔ𝑥𝑡 + ∑𝑖=1 Ω𝑖 Δ𝑧𝑡−𝑖 + 𝑐0 + 𝑐1 𝑡 + ϵ𝑡 (2)

The marginal equation for the weakly and fully exogenous variables is identified as
𝑝−1
Δ𝑥𝑡 = ∑𝑖=1 Γ𝑥 𝑖Δ𝑧𝑡−1 + 𝑎𝑥0 + 𝜐𝑥𝑡 (3)

We use the assumption that the foreign variables in xt are weakly exogenous (also known as
long-run forcing for yt) in the long-run multiplier matrix Π of a normal VECM. The
assumption of weak exogeneity in the VECX* model corresponds to Π𝑥 = 0, where Π is
separated as Π′ = (Π𝑦′ , Π𝑥′ ). Therefore, the long-run multiplier matrix of a VECX* model is
Π𝑦 , as indicated in equation (2), while the marginal or subsystem VECM model for the weakly
exogenous foreign variables does not contain cointegrating vectors of the overall VECX*
model since Π𝑥 = 0 (Pesaran et al., 2000). Equation (3) shows the marginal equation for
foreign variables. Weak exogeneity, therefore, implies that domestic variables do not affect
foreign variables in the long-term since the domestic economy is small and open. This
assumption is essential for modelling macroeconomic variables for Zambia since it is a small
and open economy. In addition to the weakly exogenous variables, we include fully
exogenous variables which are determined completely outside the model and are not
cointegrated with the variables in the main model.

As part of the robustness checks, we extend our analysis to include a measure of fiscal policy
as a variable in our model. We include the fiscal deficit to see how monetary and fiscal policy
interact to influence inflation and provide insight into the effect on the monetary
transmission process. This is relevant given that fiscal policy remains a powerful tool for
macroeconomic policy and stability as noted by Arestis and Sawyer (2004). Evidence from
Nigeria indicated that fiscal policy was a source of distortion in terms of the desired policy
impact or direction on target variables and not complementary to monetary policy (Adefeso
and Mobolaji, 2010; Ajisafe and Folorunso, 2002).

The VECX* modelling strategy follows from Garratt et al. (2006) and begins with an
examination of the long-run relations among variables in the model based on
macroeconomic theory. The identified relations are then embedded into the long-run
reduced form shocks in the otherwise unrestricted VAR model to obtain the cointegrated
VAR model which incorporates the long-run relations in the steady state solution.

DATA SOURCES AND DESCRIPTION

We use quarterly data from April 2012 to June 2022. The domestic variables included in the
model are the monetary policy rate, prt, inflation, πt, real broad money supply (M3), m3t, real
gross domestic product (GDP), yt, the nominal interest rate, proxied by the interbank rate, rt,
and the real exchange rate, ept. These variables are treated as endogenous. The policy rate
for the quarter is selected in the month when the monetary policy decision is announced. To
account for the exchange rate transmission channel, we further include as a weakly
𝑓
exogenous variable, the inflation rate of South Africa, 𝑝𝑡 . We use the South African inflation
due to strong trade links between Zambia and South Africa as demonstrated by Chipili
(2022) who found that 40 percent of Zambia’s imports on average are sourced from South
Africa. Given the importance of the US market and the federal funds rate for investor decision
making globally, we use the federal funds rate as the proxy for international interest rates.

We also include three fully exogenous variables, namely the price of oil, 𝑝𝑡𝑜𝑖𝑙 , a dummy
variable to account for the negative economic effect (proxied by GDP) of the COVID-19 shock,
dgdpt, coded as 1 for periods between December 2019 and January 2021 and 0 otherwise,
and a dummy variable for drought-related agriculture production, dmt, coded as 1 for
expected lower maize production in the farming season period after a drought and 0
otherwise. The selection of the exogenous variables is informed by empirical studies on the
key drivers of inflation for Zambia (Chipili, 2022; Mohanty & John, 2015; Nguyen et al., 2017)
as well as the need to account for the negative economic effects that arose from the COVID-
19 pandemic. Lower maize production is selected to represent supply-side disruptions that
occur after droughts as maize and maize products are the biggest component of the food
basket and a key driver of inflation (Chipili, 2022) accounting for up to 55 percent of total
inflation. In the supplementary analysis, we extend our model to include a measure of fiscal
policy, the fiscal deficit (𝑓𝑡𝑝 ) and assess the implications for monetary policy effectiveness.
Sources and transformations of all data are described in more detail in Table A.1. Unit root
examination show that all the variables can be regarded as I (1) (Table 1).

Table 3: Augmented Dickey Fuller and Phillip – Perron Unit Root Test Results

ADF PP Order of integration

Level 1st Difference Level 1st Difference
Endogenous Variables
Policy rate -1.190 -4.324 -1.543 -4.325 I (1)
Inflation rate -1.218 -4.351 -1.443 -4.185 I (1)
Exchange rate -1.825 -4.453 -2.244 -4.424 I (1)
Domestic interest rate -1.958 -5.057 -2.052 -4.949 I (1)
GDP -2.163 -8.526 -1.823 -15.353 I (1)
Money Supply -3.259 -8.126 -3.288 -8.227 I (1)
CPI South Africa -1.893 -6.233 -1.799 -6.244 I (1)
Exogenous variables
Oil price -1.464 -5.179 -1.713 -5.224 I (1)
Foreign interest rate -1.194 -3.310 -1.633 -3.414 I (1)
Fiscal Deficit -2.889 -9.053 -2.655 -12.212 I (1)
Notes: ADF and PP Critical Values for the policy rate, domestic interest rate, GDP, oil price, foreign interest rate
and the fiscal deficit: At levels 1% (-3.648) 5% (-2.958) 10% (-2.612); At first difference, 1% (-3.655) 5% (-
2.961) 10% (-2.613). ADF and PP Critical Values for the inflation rate, exchange rate, money supply and South
African CPI: At level 1% (-4.242), 5% (-3.540), 10% (-3.204); At first difference 1% (-4.251), 5% (-3.544)10%
(-3.206). Source: Authors computation from Zambia Statistics Agency (2022), South African Statistics Agency
(2022), Ministry of Finance and National Planning (2022).
IDENTIFICATION OF LONG-RUN RELATIONSHIPS

The first step in the development of the VECX* model is the identification of long-run
relationships that exist among variables of interest (Assenmacher-Wesche and Pesaran,
2008). This allows us to account for monetary policy transmission channels given that the
relationship between the policy rate and inflation is not direct. From economic theory, we
examine four relationships, namely, the Purchasing Power Parity (PPP), Uncovered Interest
Parity (UIP), money demand (MD) and Fisher Parity (FP) relations representing the various
channels of transmission.

The proposition that once converted to a common currency, national price levels should be
equal is known as the PPP and is represented by equation (4).

𝑃𝑃𝑃: 𝑒𝑡 − (𝑝 − 𝑝 ∗) = 𝑏11 + 𝑏12 + η1𝑡 (4)

The underlying notion is that given the enforcement of goods market arbitrage in prices
across a basket of individual goods (the law of one price), there should also be a high
correlation in aggregate price levels (Rogoff, 1996). Within our model, this implies that
domestic and foreign prices will be in equilibrium in the long-run.

The UIP postulated by Fama (1984) relates domestic and foreign interest rates and suggests
that the interest differential between two countries should equal the expected exchange rate
change as shown in equation (5).

𝑈𝐼𝑃: 𝑟𝑡 − 𝑟 ∗= 𝑏21 + 𝜂2𝑡 (5)

The Fisher Parity or Fisher Effect is represented by equation (6) and links domestic interest
rate changes to the domestic inflation rate. The standard view is that changes in short-term
interest rates primarily reflect fluctuations in expected inflation inferring that they have
predictive ability for future inflation (Mishkin, 1992).
𝐹𝑃: 𝑟𝑡 − π𝑡 = 𝑏31 + 𝜂3𝑡 (6)

The money demand relationship links money supply growth to output and interest rate and
can be represented as:
𝑀𝐷: 𝑚𝑡 − 𝑦𝑡 − β𝑟𝑡 = 𝑏41 + 𝜂4𝑡 (7)
The four long-run relations can be written compactly as:
η𝑡 = β′ 𝑧𝑡 − 𝑏1 − 𝑏1𝑡
Where 𝑏1 = (𝑏11 , 𝑏21 , 𝑏31 , 𝑏41 ) and 𝑏2 = (𝑏21 , 0,0,0).
To test these relationships, we use domestic interest rates, the policy rate, the domestic
price rate (consumer price index), nominal exchange rate, real money supply and real
output. Foreign variables included are the foreign price level (consumer price index for
South Africa) and the foreign interest rate (proxied by the United States Federal Funds Rate).
The trends in movements that suggest the existence of long-run relations between the
endogenous and exogenous variables are graphically depicted in Figures 2 – 6 both in levels
and first difference. Due to the apparent correlation between the nominal exchange rate and
output (Figure 3 and Table A.1. of the appendix), we estimate PPP as (𝑝∗ − 𝑝 − 𝑒) and further
consider the augmented PPP given by (𝑒 − (𝑝 − 𝑝∗ ) − β1 (𝑦)). From figures 2 and 3, there is
evidence that both the exchange rate and difference in prices of domestic and foreign goods
have the same trend suggesting the existence of the PPP relationship for Zambia. A positive
relationship between output and the exchange rate is also observed, implying that
estimation of the PPP relation should incorporate this dynamic.

Figure 2: Long-term Trends between the Exchange Rate and Prices

Notes: The figure illustrates the long-term relationships between the nominal exchange rate and the difference
between the domestic and foreign prices, measured using their rates of inflation. p= domestic consumer price
index (CPI), p*=foreign CPI (proxied by the South African CPI). Source: Bank of Zambia, Statistics South Africa.

Figure 3: Long-term Trends between the Exchange Rate and Output

Notes: The figure illustrates the long-term relationships between the nominal exchange rate and output. GDP=
Gross Domestic Product (GDP). Source: Bank of Zambia, Zambia Statistics Agency.

The evolution of real money supply (M3), short-term interest rates and real GDP is
illustrated in Figures 4 and 5. The money demand (MD) association is defined by 𝑚 − β2 𝑦 −
β3 𝑟 and all three series graphically exhibit volatility although there is some evidence of a
relationship between the variables. The illustration suggests presence of a negative interest
rate elasticity and positive income elasticity as expected a priori.

Figure 4: Long-term Trends between Money Supply and GDP

Notes: The figure illustrates the long-term relationships between GDP and money supply GDP=Gross Domestic
Output, M3= broad money supply. Source: Bank of Zambia, Zambia Statistical Agency.

Figure 5: Long-term Trends between Money Supply and Nominal Interest Rates

Notes: The figure illustrates the long-term relationships between money supply and the nominal interest rate.
NIR = nominal domestic interest rate proxied by the interbank rate, M3= broad money supply. Source: Bank of
Zambia, Zambia Statistical Agency.
Domestic and foreign interest rates do not follow the same trend, with Figure 6 suggesting
lagged changes in the foreign rate of interest. This brings into question the validity of the UIP
for Zambia. With regard to the Fisher effect, Figure 7 alludes to the existence of a long-term
relationship, particularly when observed for the differenced observations, with similar trend
movements between the domestic rate of inflation and the nominal interest rate.

Figure 6: Long-term Trends between Domestic and Foreign Interest Rates

Notes: The figure illustrates the long-term relationships between the policy rate and the foreign interest rate
(proxied by the Federal Funds Rate). FFR = Federal Funds Rate.
Source: Bank of Zambia, Federal Reserve Bank.

Figure 7: Long-term Trends between Domestic Inflation and Nominal Interest Rates

Source: Bank of Zambia, Zambia Statistical Agency.

We use the cointegrated VAR approach to confirm the validity of the results and determine
causality of the relationships. The foreign variables are assumed to be endogenously
determined for this purpose although given the small size of the Zambian economy, this may
be unlikely. We impose the restriction of one cointegrating relation to identify the long-run
relation and introduce a dummy variable in the estimation of the money demand equation
to take into account structural breaks detected in the GDP series. The formal test results are
summarized in Table 2.

We find evidence of 3 long-run relations – the PPP, money demand and the Fisher Effect.
There is no evidence of cointegration between the domestic and foreign rates of interest,
implying that the UIP channel may not be effective for Zambia4. As a further check for the
UIP, we tested for the existence of a long-run relation using the 10-year bond rates for
Zambia and the USA and also found no evidence of cointegration5. This may, however, reflect
insufficient variables to detect this relationship, with Pesaran et al. (2000) using Monte Carlo
simulations to show that cointegrating rank test statistics generally tend to under-reject in
small samples6. Unlike de Waal (2014) and Affandi (2007), the money demand/output
channel is found to be valid after controlling for the structural break in output caused by the
onset of the COVID-19 pandemic.

Table 2: Long-term Economic Relationships: VECM Cointegration Test Results

Error Correction Standard Error CI bounds2 Lag length3 Rank
Term1
PPP -0.237* 0. 130 - 0. 451 -0.022 4 1
MD - 0.104* 0.044 -0.177 -0.032 4 1
FP -0.291* 0.080 - 0.423 -0.159 2 1
Notes: 1 A significant p-value is indicated by * (10percent level of significance).
2 Lower and upper 90percent confidence interval bounds
3 Lag length selected by the Akaike Information Criterion (AIC). The models include an intercept except

for the PPP and MD where a dummy variable is included for the COVID-19 related structural break in
GDP from 2020. PPP = purchasing power parity, MD= money demand, FP = Fisher Parity.

The long-term equations from the error correction method for the valid relations are
presented below, with the standard errors of the coefficients shown in brackets. The real
exchange rate, ep, is calculated from the nominal exchange rate and the ratio of the foreign
and domestic price rate7. The coefficients are all statistically significant, with the exception
of the interest rate which is not significantly different from one in the MD equation.

𝑒𝑝𝑡 = 7.859𝑝𝑡∗ − 3.015𝑦𝑡 + 1.028 𝑑𝑔𝑑𝑝𝑡 + 𝜖𝑡1 (8)

(0.688) (0.304) (0.267)

𝑚𝑠𝑡 = 0.041𝑟𝑡 + 1.220𝑦𝑡 − 0.041 𝑑𝑔𝑑𝑝𝑡 + 𝜖𝑡2 (9)

(0.005) (0.006) (0.080)

4 Results from the ARDL cointegration approach are presented in Table A.3. of the appendix. The statistics
confirm the validity of the three long-run relationships identified using the vector error correction approach.
5
The graphical illustration of the relationship between domestic and foreign bond interest rates are provided
in Figure A.2. of the appendix.
6
Pesaran et al. (2000) define their sample of 60 observations as small but the general rule of thumb is that a
series less than 30 is considered as small.
7
The real exchange rate is calculated as follow: 𝑒𝑝𝑡 = 𝑁𝐸𝑅𝑡 ∗ (𝑝∗ /𝑝)
 𝑟𝑡 = 78.424 − 13.442𝜋𝑡 + 𝜖𝑡3 (10)
(4.251)

In summary, the data indicates the existence of some long-run relationships as postulated by
economic theorem. The preliminary data analysis is used to inform the choice of variables
and restrictions to impose in the model and given that we do not find a significant
relationship for the UIP, we do not include the foreign interest rate in the model. The VECX*
is used to interrogate the interactions amongst these variables collectively.

6. MODEL RESULTS AND DISCUSSION

The lag length selected for the VECX* estimation was determined by the Akaike Information
Criterion (AIC) and Hannan–Quinn information criterion (HQC) which indicated an optimal
lag length of 3 for the structural VAR. While the Akaike's Final Prediction Error (FPE) and
Schwarz information criterion (SIC) selected a lag length of 2 and 1 respectively, it has been
argued that for vector autoregressive models, the AIC is superior and tends to produce the
most accurate structural and semi-structural impulse response estimates for representative
sample sizes (Ivanov and Kilian, 2005; Liew, 2004).

The results of the cointegration tests for the model with linear deterministic trend are
presented in Table 3. The trace statistic suggests a rank of 3 at the 5 percent level of
significance. This indicates the presence of three cointegrating relations in the model and is
in line with the identified long-run economic relations.
Table 3: Cointegration Test Results
Trace Test 95percent critical 99percent critical
Rank Statistic value value
r=0 250.96 125.62 135.97
r=1 126.57 95.75 104.96
r=2* 71.02 69.82 77.82
r=3** 24.85 47.86 54.68
r=4 13.68 29.80 35.46
r=5 6.15 15.49 19.94
Notes: * Indicates the number of cointegrating equations detected at the 1percent level, ** indicates the number
of cointegrating relationships detected at the 5percent level.

The long-run relations identified are the PPP, money demand and Fisher Parity. Thus, we
impose restrictions on these three relations on the basic VECX* model to identify the model.
Recalling that our VECX* model is represented as 𝑧𝑡 = (p ∗, πt , 𝑦𝑡 , 𝑒𝑝𝑡 , 𝑚𝑠𝑡 , 𝑟𝑡 , 𝑝𝑟𝑡 )′ , we
consider the case of three cointegrating vectors in line with the focus of this paper and
estimate both the short-run and the long-run dynamics of the model. In line with the PPP,
the first cointegrating vector restrictions are as follows: p ∗= −1, πt = 0, 𝑦𝑡 =. , 𝑒𝑝𝑡 =
1, 𝑚2𝑡 = 0, 𝑟𝑡 = 0, 𝑝𝑟𝑡 = 0. The second cointegrating vector relates to the money demand
function and the following variables are restricted: p ∗= 0, πt = 0, 𝑦𝑡 = 1, 𝑒𝑝𝑡 = 0, 𝑚2𝑡 =
1, 𝑟𝑡 = 1, 𝑝𝑟𝑡 = 0. The final cointegrating vector is the Fisher Parity, and the restrictions are
as follows: p ∗= 0, πt = 1, 𝑦𝑡 = 0, 𝑒𝑝𝑡 = 0, 𝑚2𝑡 = 0, 𝑟𝑡 = 1, 𝑝𝑟𝑡 = 0. We further impose
restrictions on the speed of adjustment coefficients for the weakly exogenous foreign
variable, (A matrix=0), so that it does not respond to changes in domestic variables over the
long-term in line with the estimation strategy.
The estimates of the cointegrating vectors are presented in equations (11) to (13), with the
standard errors in parentheses. The intercepts of the three equations are b10, b20, and b30
while the error terms are given by 𝜃1𝑡 , 𝜃2𝑡 and 𝜃3𝑡 , respectively.
𝑃𝑃𝑃: 𝑒𝑝𝑡 = 𝑝𝑡∗ + 28.879𝑦 + 𝑏10 + θ1𝑡 (11)
(2.025)

FP: 𝑟𝑡 = −π𝑡 + 𝑏20 + θ2𝑡 (12)

𝑀𝐷: 𝑚𝑠𝑡 = 𝑦𝑡 − 𝑟𝑡 + 𝑏30 + θ2𝑡 (13)

The reduced form error correction statistics and select diagnostics statistics from the
restricted model are presented in Table 4. We see that the lagged error correction terms
from the long-run relations, also referred to as deviations, are significant for several of the
equations. The error correction terms for inflation also have the appropriate sign as required
for dynamic stability in the PPP and Fisher Parity equations. Deviations from the Fisher
Parity explain changes in inflation and the real exchange rate, while deviations from the
money demand relation is significant for inflation and money supply. The lagged error
correction term from the PPP is significant for output and money supply.
Table 4: Reduced Form Error Correction Equations
𝚫𝐩 ∗𝐭 𝚫𝛑𝐭 𝚫𝒚𝒕 𝚫𝒆𝒑𝒕 𝚫𝒎𝒔𝒕 𝚫𝒓𝒕 𝚫𝒑𝒓𝒕
𝜃1,𝑡−1 0.000 0.011* -0.003 -0.040 0.005 -0.240 0.316*
𝜃2,𝑡−1 0.000 0.092* -0.013 -0.561 -0.049 -5.822* 2.129*
𝜃3,𝑡−1 0.000 -0.094* 0.021 0.570 0.046 5.340 -2.207*
Δp ∗t−1 -0.456 0.007 1.464 -10.919 -0.249 55.848 -4.871
Δπt−1 0.124 0.033 0.414 -7.824* 0.666 44.907 -23.882*
Δ𝑦𝑡−1 -0.006 0.108 -0.491 -2.245 0.327 -3.934 6.618*
Δ𝑒𝑝𝑡−1 0.001 -0.007 -0.026 -0.454 -0.058 0.515 0.989
Δ𝑚𝑠𝑡−1 -0.014 0.024 0.086 2.293* -0.547 4.126 -6.730*
Δ𝑟𝑡−1 0.000 0.003* -0.004 0.040 0.006 0.201 0.059
Δ𝑝𝑟𝑡−1 0.003* 0.003 0.017 0.157* 0.030 2.338* 0.228
Intercept -0.034 0.195* -0.173 3.886* 0.426 16.823* 4.294
Δ𝑝𝑡𝑜𝑖𝑙 0.014* -0.039* 0.035 -0.741* -0.073 -4.431* -0.454
Δ 𝑑𝑔𝑑𝑝𝑡 0.000 0.000 -0.010 0.298 0.103 1.150 -1.844*
Δ𝑑𝑚𝑡 -0.003 0.000 -0.002 -0.144 -0.013 0.204 -0.420
Adjusted R2 0.410 0.710 0.262 0.606 0.126 0.691 0.655
F-stat 2.285 5.539 1.657 3.842 1.268 5.146 4.519
Log likelihood 165.267 131.157 81.766 17.894 66.572 -53.034 -13.968
Notes: * Denotes significance at the 5 percent level.

The impulse response functions from the estimated regression show that an increase in the
policy rate leads to a slowdown in inflation after two quarters before it starts declining after
a lagged effect of four quarters (figure 8). The effects of a change in the policy rate continue
up to 6 quarters before dissipating. We observe a ‘price puzzle’ in our baseline results of two
quarters which is higher than de Waal and van Eyden (2014) found for South Africa (one
quarter), before the inflation rate declines as anticipated when there is a shock to monetary
policy. Similar models from Switzerland (Assenmacher-Wesche and Pesaran, 2008),
Indonesia (Affandi, 2007), and Thailand (Akusuwan, 2005) also exhibit price puzzles which
last longer. This is despite our model incorporating supply-side food shocks as well as
including oil prices (commodity prices), both of which enter as exogenous variables, and are
key drivers of inflation in Zambia. The price puzzle refers to the counterintuitive increase in
inflation in response to a tightening of monetary policy found in impulse response functions
obtained from structural VARs. Estrella (2015) shows, using data from the United States, that
a possible solution to the puzzle could be the exclusion of the first lag of the policy rate and
consequently from the reduced-form equation for inflation. Sims (1992) suggests integrating
a measure of commodity price increases in the VAR as a proxy for unobserved inflation
expectations because he hypothesizes that central banks have internal information about
inflation expectations that is not reflected in the standard VAR structure. Other scholars,
such as Kim (1999), Kim and Roubini (2000) and Sims and Zha (1999) have followed in his
footsteps and included other indices of commodity prices in structural VARs.
After seven quarters, we see the inflation rate rising again suggesting that the effect of a
policy change may be transitory. This is also consistent with a priori expectations of
monetary policy neutrality in the long-run.
Figure 8: Generalized Impulse Response Function to a One Standard Error Shock to the Policy
Rate

Response of inflation to a policy rate Innovation

.02

.01

.00

-.01
1 2 3 4 5 6 7 8
Notes: The figure illustrates the effect of a shock to the policy rate on inflation. The impulse response functions
Response to Generalized One S.D. Innovations 95percent CI using Standard percentile bootstrap with 999
bootstrap repetitions. The full matrix of impulse response functions is provided in the appendix.

Further, the forecast error decomposition for inflation (Table 5) supports the effectiveness
of the exchange rate monetary policy transmission channel in Zambia. We find that after four
quarters, changes in inflation are largely explained by the policy rate (17.4percent) and the
exchange rate (13.9 percent). Over the medium-term (after eight quarters), we find that
innovations in inflation are still largely due to these two factors. Our findings therefore
suggest that the exchange rate channel is a more effective channel of monetary policy
transmission as opposed to money supply or the nominal interest channel. Nonetheless, we
find evidence of money supply impacting inflation throughout our forecast horizon,
accounting for an average of 5 percent of innovations in inflation. The relevance of money
supply in explaining changes to inflation is in line with findings by Mwafulirwa (2017) who
postulated that monetary aggregates were effective in stabilizing prices.
Table 5. Forecast Error Variance Decomposition of Inflation
Period S.E. P* πt yt ept mst rt 𝑝𝑟𝑡
1 0.01 0.03 99.97 0.00 0.00 0.00 0.00 0.00
2 0.02 0.54 85.17 0.04 4.60 5.93 1.23 2.50
4 0.03 1.72 60.28 1.15 13.83 4.42 1.24 17.35
6 0.04 7.43 53.15 2.41 15.65 5.50 1.01 14.86
8 0.04 6.19 53.61 2.28 17.51 5.41 1.01 13.99
Source: Authors computation

The rest of the section discusses the results from the model extension to include fiscal policy.
A lag length of 3 is used and three cointegrating equations are identified. We impose three
restrictions to account for the PPP, FP and MD relations and the impulse response functions
from the estimation are illustrated in Figure 9.
Figure 9: Inclusion of fiscal deficit – generalized impulse response function showing inflation
response to a one standard error shock to the policy rate.

Response of inflation to a policy rate innovation (including fiscal deficit)

.04

.02

.00

-.02
1 2 3 4 5 6 7 8
Notes: The figure presents the effects of an innovation to the policy rate on inflation when fiscal policy
(measured by the fiscal deficit) is introduced as an endogenous variable in the model. The figure shows the
response of inflation to a generalized one standard deviation innovation in the policy rate using 95 percent
confidence intervals. The full matrix of impulse response functions is provided in the appendix.

When a measure of fiscal policy is introduced within the model, we see that monetary policy
remains effective and the overall impact on inflation increases in the first four quarters. This
suggests that fiscal policy implementation may augment the efficacy of the monetary policy
transmission process. This contradicts other empirical findings from previous studies that
find the fiscal deficit is inflationary in nature (Catao and Terrones, 2005; Khumalo, 2013; Lin
and Chu, 2013; Narayan et al., 2019). These expectations which are anchored on economic
theory suggest that the budget deficit is usually financed by borrowing or printing of money,
both of which result in higher inflation (Mishkin, 2007a). However, we posit that for Zambia,
budget financing through borrowing from the domestic market may crowd out the private
sector and reduce inflationary pressures by constraining aggregate demand. At the same
time, borrowing may increase government expenditure and result in higher inflationary
pressure. The net effect of fiscal borrowing would depend on which outcome outweighs the
other. We find a negative relationship between inflation and the fiscal deficit8, lending
credence to the argument that fiscal policy may constrain aggregate demand in the long-run,
thus augmenting monetary policy. Indeed, for Zambia, Bulawayo et al. (2018) found that
fiscal deficit is not inflationary in the long-run.
The forecast error decomposition of inflation when fiscal deficit is incorporated in the model
supports the effectiveness of the money supply and exchange rate policy transmission
channels (Table 6). We see increased relevance of money supply in explaining changes in
inflation when fiscal policy is taken in account and find that after four quarters, money
supply is the main factor explaining changes to inflation (18.7 percent), with the effects
increasing by the eighth quarter (25.4 percent). Nonetheless, the exchange rate and policy
rate also remain key explanatory variables of changes in inflation.
Table 6. Forecast Error Variance Decomposition of Inflation (when fiscal policy is included)
S.E. P* 𝑝 πt yt ept mst rt
Period 𝑓𝑡 𝑝𝑟𝑡
1 0.01 2.01 10.71 87.28 0.00 0.00 0.00 0.00 0.00
2 0.02 4.91 7.30 73.56 0.05 5.09 8.08 0.27 0.75
4 0.03 6.60 7.11 46.24 5.54 11.36 18.68 1.15 3.32
6 0.04 9.43 4.14 39.07 5.83 8.63 25.37 1.87 5.65
8 0.05 9.98 5.43 37.16 4.54 11.43 25.41 1.29 4.75
Source: Authors computation

7. CONCLUSION
The study uses a new model, VECX, to investigate the effect of a change in monetary policy
on inflation in Zambia. The model includes exogenous variables to capture the effect of
supply-side shocks as well as to account for key external factors that drive inflation
domestically. Three statistically significant long-run relationships namely the PPP, money
demand (interest rate elasticity) and the Fisher Parity are identified. In the main model, we
include restrictions for the three long-run relationships and results from the impulse
response functions indicate a lag of two quarters for innovations to monetary policy to slow
down inflation. A steep decline in the rate of inflation is observed after four quarters while
stabilisation occurs after six quarters. We find that inclusion of fiscal deficit in the model
augments the extent to which innovations in the policy rate reduces inflation in the short-
run. The results generally point to the effective transmission of monetary policy to inflation
in Zambia between 2012 and 2022.

8The correlation matrix which shows the negative relation between inflation and the fiscal deficit is shown in
Table A.4. of the appendix.
The findings reinforce the argument that monetary policy effects are not contemporaneous,
and the model set up suggests that the analysis of monetary policy can be improved by
incorporating domestic supply-side factors, fiscal policy as well as external variables. In
terms of policy implications, the results suggest that the current inflation targeting
framework is appropriate for Zambia though the role of monetary aggregates as key
determinants of inflation has been vastly reduced. We suggest that monetary policy
implementation can be enhanced by increased focus on ensuring stability in the foreign
exchange market and complementarity between fiscal and monetary policy.
For future research, it might be important to develop a model that compares the
effectiveness of monetary policy before inflation targeting was adopted in 2012 and the post
effects. This would provide a more comprehensive analysis on the appropriateness of
inflation targeting for developing countries as opposed to the monetary aggregate targeting.
Our model can also be extended to include global economic shocks as well as fully
incorporate fiscal policy in the monetary transmission process. An investigation of the
Zambian economy and monetary policy would be aided by the development of a full
macroeconomic model which would enable for an in-depth analysis of the effect of different
variables contemporaneously. Finally, more rigorous analysis of the impact of monetary and
fiscal policy on inflation may provide requisite evidence on how these policies interact in
developing countries.
REFERENCES

Adefeso, H. A., & Mobolaji, H. I. (2010). The fiscal-monetary policy and economic growth in Nigeria:
Further empirical evidence. Pakistan Journal of Social Sciences, 7(2), 137–142.
Adu, G., & Marbuah, G. (2011). Determinants of inflation in Ghana: An empirical investigation. South
African Journal of Economics, 79(3), 251–269.
Affandi, Y. (2007). Small Monetary System for Indonesia: A Long Run Structural Approach [PhD
Thesis]. University of Cambridge.
Ahiabor, G. (2013). The effects of monetary policy on inflation in Ghana. Developing Country Studies,
3(12), 82–89.
Ajisafe, R. A., & Folorunso, B. A. (2002). The relative effectiveness of fiscal and monetary policy in
macroeconomic management in Nigeria. The African Economic and Business Review, 3(1), 23–40.
Akhsyim Afandi. (2005). Monetary Policy Transmission Mechanism and Structural Breaks in
Indonesia. University of Wollongong.
Akusuwan, M. (2005). A Small Quarterly Macro Econometric Model for the Thai Economy: A
Structural Cointegrating VAR Approach [PhD Thesis]. University of Cambridge.
Angelina, S., & Nugraha, N. M. (2020). Effects of Monetary Policy on Inflation and National Economy
Based on Analysis of Bank Indonesia Annual Report. Technium Soc. Sci. J., 10, 423.
Arestis, P., & Sawyer, M. (2004). On the effectiveness of monetary policy and of fiscal policy. Review
of Social Economy, 62(4), 441–463.
Assenmacher-Wesche, K., & Pesaran, M. H. (2008). A VECX model of the Swiss economy. CESifo
Working Paper.
Bain, M. K., & Howells, P. (2009). Monetary economics: policy and its theoretical basis. Macmillan
International Higher Education.
Bank of Zambia. (2015). Bank of Zambia 2015 Annual Report. Available online:
[Link]
Bernanke, B. S., Laubach, T., Mishkin, F. S., & Posen, A. S. (2018). Inflation targeting. In Inflation
Targeting. Princeton University Press.
Bernanke, B. S., & Mishkin, F. S. (1997). Inflation targeting: a new framework for monetary policy?
Journal of Economic Perspectives, 11(2), 97–116.
Bhattacharya, R. (2014). Inflation dynamics and monetary policy transmission in Vietnam and
emerging Asia. Journal of Asian Economics, 34, 16–26.
Bhattacharya, R., & Jain, R. (2020). Can monetary policy stabilise food inflation? Evidence from
advanced and emerging economies. Economic Modelling, 89, 122–141.
Briault, C. (1995). The costs of inflation. Bank of England Quarterly Bulletin, 35(1), 33–45.
Bulawayo, M., Chibwe, F., & Seshamani, V. (2018). The impact of budget deficits on inflation in
Zambia. Journal of Economics and Development Studies, 6(2), 13–23.
Catao, L. A. v, & Terrones, M. E. (2005). Fiscal deficits and inflation. Journal of Monetary Economics,
52(3), 529–554.
Chipili, J. M. (2022). Inflation Dynamics in Zambia-Research Report. African Economic Research
Consortium. Research paper 484.
Cottarelli, M. C. (1998). The nonmonetary determinants of inflation: A panel data study. International
Monetary Fund.
de Waal, A., & van Eyden, R. (2014). Monetary policy and inflation in South Africa: A VECM
augmented with foreign variables. South African Journal of Economics, 82(1), 117–140.
Estrella, A. (2015). The price puzzle and var identification. Macroeconomic Dynamics, 19(8), 1880–
1887.
Fama, E. F. (1984). Forward and spot exchange rates. Journal of Monetary Economics, 14(3), 319–
338.
Fischer, S. (1984). The benefits of price stability.
Friedman, M. (1961). The lag in effect of monetary policy. Journal of Political Economy, 69(5), 447–
466.
Garratt, A., Lee, K., Hashem Pesaran, M., & Shin, Y. (2003). A long run structural macro econometric
model of the UK. The Economic Journal, 113(487), 412–455.
Garratt, A., Lee, K., Pesaran, M. H., & Shin, Y. (2006). Global and national macro econometric
modelling: a long-run structural approach. OUP Oxford.
Ha, J., Ayhan Kose, M., & Ohnsorge, F. (2021). One-Stop Source: A Global Database of Inflation (No.
9737; Policy Research Working Paper).
Haabazoka, L., & Nanchengwa, C. (2016.). A study of the Effectiveness of the Monetary Policy Rate as a
Tool of Inflation Control in Zambia. Developing Country StudiesVol.6, No.5, 2016. ISSN 2224-607X
(Paper) ISSN 2225-0565 (Online).
Hangoma, P. (2010). Appropriateness of Inflation Targeting as a Monetary Policy Framework in
Zambia [MA Thesis]. University of Zambia.
Iddrisu, A.-A., & Alagidede, I. P. (2020). Monetary policy and food inflation in South Africa: A
quantile regression analysis. Food Policy, 91, 101816.
Igbafe, T. (2022). Effectiveness of Monetary Policy in Stimulating Economic Growth in Nigeria.
International Monetary Fund. (2022). World Economic Outlook Update.
Ivanov, V., & Kilian, L. (2005). A practitioner’s guide to lag order selection for VAR impulse response
analysis. Studies in Nonlinear Dynamics & Econometrics, 9(1).
Kalyalya, D. H. (2001). Monetary policy framework and implementation in Zambia. South African
Reserve Bank Conference on Monetary Policy Frameworks in Africa, 17–19.
Khumalo, J. (2013). Budget deficit-inflation nexus in South Africa: VAR analysis. Mediterranean
Journal of Social Sciences, 4(13), 415–424.
Kim, S. (1999). Do monetary policy shocks matter in the G-7 countries? Using common identifying
assumptions about monetary policy across countries. Journal of International Economics, 48(2),
387–412.
Kim, S., & Roubini, N. (2000). Exchange rate anomalies in the industrial countries: A solution with a
structural VAR approach. Journal of Monetary Economics, 45(3), 561–586.
Laryea, S. A., & Sumaila, U. R. (2001). Determinants of inflation in Tanzania. Chr. Michelsen Institute.
Liew, V. K.-S. (2004). Which lag length selection criteria should we employ? Economics Bulletin,
3(33), 1–9.
Lin, H.-Y., & Chu, H.-P. (2013). Are fiscal deficits inflationary? Journal of International Money and
Finance, 32, 214–233.
Lucas Jr, R. E. (1972). Expectations and the Neutrality of Money. Journal of Economic Theory, 4(2),
103–124.
Ma, Y., & Lin, X. (2016). Financial development and the effectiveness of monetary policy. Journal of
Banking & Finance, 68, 1–11.
Mishkin, F. S. (1992). Is the Fisher effect for real?: A reexamination of the relationship between
inflation and interest rates. Journal of Monetary Economics, 30(2), 195–215.
Mishkin, F. S. (1995). Symposium on the monetary transmission mechanism. Journal of Economic
Perspectives, 9(4), 3–10.
Mishkin, F. S. (2000). Inflation targeting in emerging-market countries. American Economic Review,
90(2), 105–109.
Mishkin, F. S. (2007a). The economics of money, banking, and financial markets. Pearson education.
Mishkin, F. S. (2007b). The economics of money, banking, and financial markets. Pearson education.
Mishkin, F. S. (2009). Is monetary policy effective during financial crises? American Economic
Review, 99(2), 573–577.
Mishkin, F. S. (2011). Monetary policy strategy: lessons from the crisis. National Bureau of Economic
Research.
Mishkin Frederic, S. (1999). International Experiences with Different Monetary Regimes. Journal of
Monetary Economics, 43.
Mishra, M. P., & Montiel, M. P. (2012). How effective is monetary transmission in low-income
countries? A survey of the empirical evidence.
Miyajima, M. K. (2021). Monetary Policy, Inflation, and Distributional Impact: South Africa’s Case.
International Monetary Fund.
Mohanty, D., & John, J. (2015). Determinants of inflation in India. Journal of Asian Economics, 36, 86–
96.
Moki Daniel Katei. (2014). Effectiveness of monetary policy in controlling inflation in Kenya. Master’s
Thesis.
Moser, G. G. (1995). The main determinants of inflation in Nigeria. IMF Staff Papers, 42(2), 270–289.
Mwafulirwa, J. (2017). Estimating Effectiveness of Monetary Policy in Zambia Using Monetary
Response Functions. Master’s Thesis – University of Botswana.
Narayan, P. K., Narayan, S., & Prasad, A. D. (2019). Modelling the relationship between budget deficits,
money supply and inflation in Fiji.
Ngoma, C., & Chanda, C. (2022). Pass-Through from Policy Rate to Retail Interest Rates in Zambia.
AERC Research paper 53.
Nguyen, A. D. M., Dridi, J., Unsal, F. D., & Williams, O. H. (2017). On the drivers of inflation in Sub-
Saharan Africa. International Economics, 151, 71–84.
Okimoto, T. (2019). Trend inflation and monetary policy regimes in Japan. Journal of International
Money and Finance, 92, 137–152.
Onwachukwu, C. I. (2014). Impact of monetary policy on inflation control in Nigeria.
Patrick, C. M., & Akanbi, O. A. (2017). The relative importance of the channels of monetary policy
transmission in a developing country: The case of Zambia. African Journal of Economic Review,
5(2), 149–174.
Pesaran, M. H., Shin, Y., & Smith, R. J. (2000). Structural analysis of vector error correction models
with exogenous I (1) variables. Journal of Econometrics, 97(2), 293–343.
Rasche, R., & Williams, M. M. (2005). The effectiveness of monetary policy. FRB of St. Louis Working
Paper No.
Ribon, S. (2011). The Effect of Monetary Policy on Inflation: A Factor Augmented VAR Approach using
disaggregated data. Bank of Israel.
Rogoff, K. (1996). The purchasing power parity puzzle. Journal of Economic Literature, 34(2), 647–
668.
Sims, C. A. (1992). Interpreting the macroeconomic time series facts: The effects of monetary policy.
European Economic Review, 36(5), 975–1000.
Sims, C. A., & Zha, T. (1999). Error bands for impulse responses. Econometrica, 67(5), 1113–1155.
Zambia Statistics Agency. (2022). Monthly Economic Bulletins. Lusaka, Zambia. Available: online:
[Link]
Zgambo, P., & Chileshe, P. M. (2014). Empirical analysis of the effectiveness of monetary policy in
Zambia. COMESA Committee of Central Bankers, 1–50.

APPENDIX A

Table A.1.: Variable definition and computation

Variable Definition Source Transformation

prt Monetary policy rate Bank of Zambia None
mst Real broad money (M3) Bank of Zambia Log of M3
yt Real Gross Domestic Product Zambia Statistics Agency Log of real GDP
(GDP)
πt Inflation rate (proxied by the Zambia Statistics Agency Log of the consumer price index.
consumer price index)
rt Nominal domestic interest rate Bank of Zambia None
(proxied by the interbank rate)
et Nominal exchange rate Bank of Zambia None
𝑝𝑡
𝑓 Foreign inflation rate (proxied by Reserve Bank of South None
the South African consumer price Africa
index Rate)
𝑝𝑡𝑜𝑖𝑙 Oil price Reuters (Dubai price) None
ffrt Foreign interest rate (proxied by Federal Reserve Bank None
the federal funds rate)
𝑝
𝑓𝑡 Fiscal policy (proxied by the fiscal Ministry of Finance and The ratio of revenue to expenditure
deficit) National Planning,
Zambia.
dmt Lower maize production Drought years obtained Coded as 1 for expected lower maize
from Chipili (2022) production in the farming season
after a year with a drought and 0
otherwise
Source: Authors computation
Table A.2: Pairwise correlation coefficients
pr π r y ms inflation ffr e P* fd ep p-p*
prt 1
πt -0.440* 1
rt 0.860* -0.326* 1
yt -0.224 0.826* -0.203 1
mst -0.346* 0.860* -0.265 0.793* 1
inf 0.062 0.600* 0.233 0.398* 0.595* 1
ffr -0.072 0.132 -0.108 0.471* 0.094 -0.294 1
e -0.386* 0.935* -0.231 0.771* 0.933* 0.726* 0.060 1
P* -0.368* 0.962* -0.265 0.910* 0.868* 0.508* 0.342* 0.909* 1
fd 0.379* -0.785* 0.315* -0.652* -0.791* -0.506* -0.015 -0.824* -0.760* 1
ep -0.245 0.829* -0.087 0.763* 0.918* 0.706* 0.160 0.961* 0.861* -0.775* 1
p-p* -0.450* 0.999* -0.335* 0.801* 0.851* 0.613* 0.089 0.931* 0.945* -0.783* 0.815* 1

Figure A.1: Graphical illustration of the key variables

Figure A.2. Long-run relationship between domestic and foreign bond rates

Table A.3: Long-term economic relationships: ARDL cointegration test results

EC t-stat CV bounds F-stat CV bounds ARDL (p,q,s)
PPP -0.73 -6.51 -3.41 -4.16 9.21 4.01 5.07 ARDL (2,4,4,2)
UIP -0.10 -1.79 -2.86 -3.22 1.57 4.94 5.73 ARDL (2,0)
FP -0.29 -3.54 -2.86 -3.22 6.03 4.94 5.73 ARDL (3,4)
MD -0.69 -6.46 -3.41 -4.16 9.43 4.01 5.07 ARDL (1,1,2,2)
Figure A.3. Impulse Response Functions
Re sponse to Ge ne ra liz ed One S .D. I nnov ations
95% CI using Standa rd pe rcentile bootstra p with 999 bootstra p repetitions
Response of LCPI_SA to LCPI_SA Innovation Response of LCPI_SA to LCPI_Z Innovation Response of LCPI_SA to LGDP Innovation Response of LCPI_SA to RER_SA Innovation Response of LCPI_SA to LM3 Innovation Response of LCPI_SA to INR Innovation Response of LCPI_SA to PR Innovation
.012 .004 .002 .002 .004 .012 .006

.008 .002 .000 .000 .002 .008 .004

-.002 .002
.004 .000 -.002 .000 .004
-.004 .000
.000 -.002 -.006 -.004 -.002 .000 -.002
-.004 -.004 -.008 -.006 -.004 -.004 -.004
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Response of LCPI_Z to LCPI_SA Innovation Response of LCPI_Z to LCPI_Z Innovation Response of LCPI_Z to LGDP Innovation Response of LCPI_Z to RER_SA Innovation Response of LCPI_Z to LM3 Innovation Response of LCPI_Z to INR Innovation Response of LCPI_Z to PR Innovation
.02 .02 .02 .015 .016 .02 .02

.01 .01 .010 .012 .01

.01 .01
.008
.00 .00 .005 .00
.004
.00 .00
-.01 -.01 .000 .000 -.01

-.02 -.01 -.02 -.005 -.004 -.02 -.01

1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Response of LGDP to LCPI_SA Innovation Response of LGDP to LCPI_Z Innovation Response of LGDP to LGDP Innovation Response of LGDP to RER_SA Innovation Response of LGDP to LM3 Innovation Response of LGDP to INR Innovation Response of LGDP to PR Innovation
.04 .02 .06 .03 .02 .04 .04

.02 .04 .02 .01 .02 .02

.00
.00 .02 .01 .00 .00 .00
-.02
-.02 .00 .00 -.01 -.02 -.02

-.04 -.04 -.02 -.01 -.02 -.04 -.04

1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Response of RER_SA to LCPI_SA Innovation Response of RER_SA to LCPI_Z Innovation Response of RER_SA to LGDP Innovation Response of RER_SA to RER_SA Innovation Response of RER_SA to LM3 Innovation Response of RER_SA to INR Innovation Response of RER_SA to PR Innovation
.2 .2 .4 .3 .2 .2 .2

.2 .1
.0 .0 .2 .0 .0
.1 .0
-.2 -.2 .0 -.2 -.2
.0 -.1

-.4 -.4 -.2 -.1 -.2 -.4 -.4

1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Response of LM3 to LCPI_SA Innovation Response of LM3 to LCPI_Z Innovation Response of LM3 to LGDP Innovation Response of LM3 to RER_SA Innovation Response of LM3 to LM3 Innovation Response of LM3 to INR Innovation Response of LM3 to PR Innovation
.04 .04 .04 .04 .08 .04 .04

.02 .02 .06 .02 .02

.02 .02
.00 .00 .04 .00 .00
.00 .00
-.02 -.02 .02 -.02 -.02

-.04 -.02 -.04 -.02 .00 -.04 -.04

1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Response of INR to LCPI_SA Innovation Response of INR to LCPI_Z Innovation Response of INR to LGDP Innovation Response of INR to RER_SA Innovation Response of INR to LM3 Innovation Response of INR to INR Innovation Response of INR to PR Innovation
4 2 2 1.0 2 4 2

1 1 0.5 1
2 1 2
0.0
0 0 0
-0.5
0 0 0
-1 -1 -1.0 -1

-2 -2 -2 -1.5 -1 -2 -2
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Response of PR to LCPI_SA Innovation Response of PR to LCPI_Z Innovation Response of PR to LGDP Innovation Response of PR to RER_SA Innovation Response of PR to LM3 Innovation Response of PR to INR Innovation Response of PR to PR Innovation
0.4 .50 .6 .8 .6 .4 .8

0.0 .25 .4 .6 .4
.0 .4
.2 .4 .2
-0.4 .00
.0 .2 .0
-.4 .0
-0.8 -.25 -.2 .0 -.2
-1.2 -.50 -.4 -.2 -.4 -.8 -.4
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8
Figure A.4 Stability of the VECX*

Inverse Roots of AR Characteristic Polynomial

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5
-1 0 1
Figure A.5. Impulse Response Functions when fiscal policy is included
Response to Generalized One S.D. Innovations
95% CI using Standard percentile bootstrap with 999 bootstrap repetitions
Re sp on se o f L CP I_ SA t o L CP I_ SA I nn ov at io n Re sp on se o f L CP I_ SA t o L DE F_ 2 I n no va ti on Re sp on se o f L CP I_ SA t o L CP I_ Z I n no va ti on Re sp on se o f L CP I_ SA t o L GD P I nn o va ti on Re sp on s e o f L C PI _S A to RE R_ S A I nn o va ti on Re sp on s e o f L C PI _S A to LM 3 I n no va t io n Re sp on s e o f L C PI _S A to IN R I n no va t io n Re s po n se o f L C PI _ SA t o P R In n ov a ti on
.02 .008 .01 .0050 .008 .02
.004 .008 .0025 .004 .008
.01 .00 .01
.000 .0000 .000
.000 .000
.00 -.01 .00
-.004 -.004 -.0025 -.004 -.004
-.01 -.008 -.008 -.02 -.0050 -.008 -.008 -.01
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Re sp on se o f L DE F_ 2 t o LC PI _S A I n no va ti on Re sp on se of LD EF _2 to LD EF _2 In no va ti on Re sp on se of LD EF _2 to LC PI _Z In no va ti on Re sp on se of LD EF _2 to L GD P I nn ov at io n Re sp on se of LD EF _2 to R ER _S A I nn ov at io n Re sp on se o f L DE F_ 2 t o LM 3 I nn ov a ti on Re sp on se o f L DE F_ 2 t o IN R I nn ov a ti on Re sp on s e o f L D EF _2 t o P R I nn o va ti o n
.2 .20 .2 .1 .10 .2 .2
.15 .1 .05 .05
.1 .0 .1 .1
.10 .0 .00
-.05
.0 -.1 .0 .0
.05 -.1 -.10 -.05
-.1 .00 -.2 -.2 -.15 -.10 -.1 -.1
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Re sp on se o f L CP I_ Z t o LC PI _S A I n no va ti on Re sp on se of LC PI _Z to LD EF _2 In no va ti on Re sp on se of LC PI _Z to L CP I_ Z I nn ov at io n Re sp on se o f L CP I_ Z t o LG DP In no v at io n Re sp on s e o f L C PI _Z t o R ER _S A In no v at io n Re sp on s e o f L C PI _Z t o L M3 In n ov at i on Re sp on s e o f L C PI _Z t o I NR In n ov at i on Re sp o ns e of LC P I_ Z to PR I nn o va ti o n
.04 .02 .04 .02 .02 .03 .04 .04
.02 .01 .02 .02
.02 .00 .01 .02
.00 .00 .01 .00
.00 -.02 .00 .00
-.02 -.01 .00 -.02
-.04 -.02 -.02 -.04 -.01 -.01 -.04 -.02
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Re sp on se o f L GD P t o L C PI _S A I nn o va ti on Re sp on se of LG DP to LD E F_ 2 I nn ov at io n Re sp on se o f L GD P t o L C PI _Z In no v at io n Re sp on s e o f L G DP to L GD P I nn o va ti o n Re sp on s e o f L G DP to R ER _S A I n no va t io n Re sp o ns e of LG D P t o LM 3 I n no v at io n Re sp on s e o f L G DP to I NR In no v at io n Re s po n se o f L G DP t o P R In n ov a ti o n
.08 .04 .050 .08 .04 .04 .050 .08
.04 .025 .04 .02 .025 .04
.02 .02
.00 .000 .00 .00 .000 .00
.00 .00
-.04 -.025 -.04 -.02 -.025 -.04
-.08 -.02 -.050 -.08 -.04 -.02 -.050 -.08
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Re sp on s e o f R E R_ SA t o L CP I_ S A I nn o va ti on Re sp on se of RE R_ SA to L DE F_ 2 I nn ov at io n Re sp on s e o f R E R_ SA t o L CP I_ Z In no v at io n Re sp on s e o f R E R_ SA t o L GD P I n no va t io n Re sp o ns e of RE R _S A to RE R _S A In no v at i on Re sp o ns e of RE R _S A to LM 3 In n ov at i on Re sp o ns e of RE R _S A to IN R In n ov at i on Re s po n se o f R E R_ S A t o PR I nn o va t io n
.50 .4 .8 .4 .2 .4 .4
.25 .2 .2 .2
.2 .4 .2 .0
.00 .0 .0
-.2
.0 .0 .0 -.2
-.25 -.4 -.2 -.2
-.50 -.2 -.6 -.4 -.2 -.4 -.4 -.4
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Re sp on s e o f L M 3 t o L C PI _S A I n no va t io n Re sp on se o f L M3 to LD E F_ 2 I nn ov a ti on Re sp on s e o f L M 3 t o L C PI _Z In n ov at i on Re sp o ns e of LM 3 to L GD P I n no v at io n Re sp o ns e of LM 3 to R ER _S A In n ov at i on Re s po n se o f L M 3 t o LM 3 In n ov a ti on Re sp o ns e of LM 3 to I NR In n ov a ti on Re s po n s e o f LM 3 t o P R In n o va t io n
.10 .04 .08 .08 .08 .08
.05 .02 .04 .04 .04 .06 .04
.04
.00 .00 .00 .00 .00
.00 .02
.00
-.05 -.02 -.04 -.04 -.02 .00 -.04
-.10 -.04 -.08 -.08 -.04 -.02 -.08 -.04
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Re sp on s e o f I N R t o L C PI _S A I n no va t io n Re sp on se o f I NR to LD E F_ 2 I nn ov a ti on Re sp on s e o f I N R t o L C PI _Z In n ov at i on Re sp on s e o f I N R t o L G DP In no v at io n Re sp o ns e of IN R to R ER _S A In n ov at i on Re sp o ns e of IN R to L M3 In n ov a ti on Re sp o ns e of IN R to I NR In n ov a ti on Re s po n s e o f IN R t o P R In n o va t io n
8 2 4 4 2 2 4 8
1 2 1 1 2
4 0 4
0 0 0 0 0
0 -4 0
-1 -2 -1 -1 -2
-4 -2 -4 -8 -2 -2 -4 -4
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8

Re s po n se o f P R to L CP I _S A In n ov a ti on Re sp on s e o f P R to LD E F_ 2 I nn o va ti o n Re sp o ns e of PR t o L C PI _Z I nn o va ti o n Re s po n se o f P R to L GD P In n ov a ti o n Re s po n se o f P R to R ER _ SA I nn o va t io n Re s po n s e o f PR t o LM 3 In n o va t io n Re s po n s e o f PR t o IN R In n o va t io n Re s p on s e of P R t o P R I nn o v at i o n
1 .8 0.5 2 .8 .8 0.8 1.0
.4 0.0 .4 0.5
0 1 .4 0.0
.0 -0.5 .0 0.0
-1 0 .0
-.4 -1.0 -.4 -0.8 -0.5
-2 -.8 -1.5 -1 -.4 -.8 -1.2 -1.0
1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8
Table A.4: Pairwise correlation coefficient between inflation and fiscal deficit

Deficit Inflation
Deficit 1.000
Inflation -0.785* 1.000

APPENDIX B
Table B.1: Summary Literature Review
Authors Country (title) Objective Main variables and Result
estimation model
Strand 1: to studies that have sought to understand effectiveness of monetary policy
International studies on monetary policy effectiveness
1 Igbafe (2022) Nigeria Investigated the Annual data (1990 ARDL bounds test showed a long run
(Effectiveness of influence of interest and 2019): Real relationship among the variables while the
Monetary Policy rate on output in GDP, interest rate, results of the error correction mechanism
in Stimulating Nigeria, to examine the reserve (ECM) test indicate an 88percent adjustment
Economic effect of monetary requirement, back to equilibrium. The study recommended
Growth in policy rate on the level liquidity ratio, that monetary policy must be employed in
Nigeria.) of output in Nigeria monetary policy stimulating growth since both interest rates
and to investigate how rate and inflation. and reserve requirement are affect growth in
reserve requirement the long run.
affects economic Model:
growth in Nigeria. Autoregressive
Distributed Lag
(ARDL) model, Error
Correction (ECM)
Model.
2 Bhattacharya Various countries Analysed the Quarterly data An unexpected monetary tightening had a
and Jain (Can monetary effectiveness of (2006 to 2016): Real positive and significant effect on food
(2020) policy stabilize aggregate demand GDP, real inflation in both advanced and emerging
food inflation? channel in presence of consumption, real economies. This implies that in the backdrop
Evidence from production cost investment, food of inflationary pressure arising from the food
advanced and channel of monetary CPI, core CPI, sector, a monetary tightening may turn out to
emerging policy transmission, headline CPI, policy be destabilising for the food as well as overall
economies.) affecting prices rate and exchange inflation in the economy.
positively via supply rate.
side for developed and
emerging economies. Model: Panel Vector
Autoregression
(PVAR)
3 Angelina and Indonesia The study focused on Time series data: The results of the study concluded that both
Nugraha (Effects of analysis (1) money money supply, Bank money supply and its one period lag had a
(2020) Monetary Policy supply effect, previous Indonesia significant and positive impact on inflation,
on inflation and period money supply, Certificate and the SBI rate had a significant and negative
national the level of SBI (Bank exchange rate as effect on inflation while exchange rate had a
economy in Indonesia Certificate), explanatory significant and positive effect on inflation.
Indonesia.) the exchange rate, and variables.
the economy on
inflation in Indonesia. Model:
Simultaneous
analysis model
equation of the Two-
Stage Least Squared
(TSLS) method
4 Iddrisu and South Africa To explicitly analyse Monthly data (2002 The study concluded that: (1) A restrictive
Alagidede (Monetary policy the relationship to 2018): food monetary policy is destabilizing for food
(2020) and food inflation between monetary inflation, monetary prices in South Africa. (2) Destabilization is
in South Africa: A policy and food prices policy, more pronounced at the upper quantiles of
quantile in the African context transportation cost, food price distribution. (3) Cost of
regression and especially on exchange rate, transportation fuels food inflation but only
analysis.) output and the significantly at the median.
 inflation targeting world food price (4) The depreciation of the Rand fuels food
country. index. inflation at the 25th and 50th quantiles. (5)
World food price index is important in food
Model: Quantile price dynamics in South Africa.
regression method.
5 Okimoto Japan (Trend Examined the Monthly data (1985 Results suggested a strong connection
(2019), inflation and dynamics of trend – 2016): CPI, between the trend inflation and monetary
monetary policy inflation in Japan over industrial policy regimes. Results further indicated the
regimes in the last three decades production index, significance of exchange rates in explaining
Japan.) based on the smooth nominal effective the recent fluctuations of inflation and the
transition Phillips exchanger rate, oil importance of oil and stock prices in
curve model. prices, and stock maintaining the positive trend inflation
prices. regime.

Model: Hybrid
Phillips curve
model, VAR.
6 Moki, 2014 Kenya To determine the Annual data (1980 The results indicated that nominal exchange
(Effectiveness of effectiveness of to 2013): Inflation, rate is the major factor in controlling inflation
monetary policy monetary policy in Exchange rate, 91 in Kenya. Therefore, policy makers should
in controlling controlling inflation in days treasury bill concentrate on stabilising the nominal
inflation in Kenya. rate, money supply exchange rate. Instead of focusing on world
Kenya.) (M3), GDP growth, food prices, the government should consider
oil prices, world measures aimed at increasing food supply.
prices. This involves providing credit facilities to
farmers, subsidized fertilizers and providing
Model: Ordinary new technologies to farmers to increase food
Least Squares (OLS) supply.
7 Onwachukwu Nigeria (Impact The paper attempted (1970 to 2010): The study found that bank rate, deposit with
(2014) of Monetary to assess effectiveness inflation explained the central bank of Nigeria, liquidity ratio and
Policy on of monetary policy to as a function of bank broad money were statistically significant in
Inflation Control check inflation in rate, deposit with explaining changes in inflation.
in Nigeria.) Nigeria. central bank of
Nigeria, exchange
rate, liquidity ratio,
and broad money.

Model: Ordinary
Least Squares (OLS).
8 Bhattacharya Vietnam The study attempted Quarterly data Findings point to nominal effective exchange
(2014) (Inflation to answer two key (1991 to 2012): CPI rate as key driver of inflation in the short run
dynamics and questions namely, (i) (headline) inflation, while credit growth has a significant positive
monetary policy what are the key real GDP growth, impact on inflation over the medium-term
transmission in drivers of inflation in growth in credit to horizon of 2–10 quarters. Positive growth
Vietnam and Vietnam, and what the economy, shocks generate inflationary pressures after
emerging Asia.) role does monetary nominal interest 4 quarters, and the impact lasts for the next 5
policy play? and (ii) rate, change in quarters. Interest rate shocks have a
why has inflation in nominal effective significant impact on GDP growth and on
Vietnam been exchange rate, credit growth over the short- to medium-
persistently higher change in import term.
than in most other price deflator.
emerging market
economies in the Model: Vector
region? Autoregressive
(VAR) model and
Ordinary Least
Squares (OLS).
9 Ahiabor Ghana (The To determine the Annual data (1985 The results showed a long-run positive
(2013), Effects of effects of Monetary to 2009): interest relationship between money supply and
Monetary Policy Policy on Inflation in rate, exchange rate inflation, negative relationship between
on Inflation in Ghana and money supply, interest
Ghana.) inflation as rate and inflation, however, a positive
variables. relationship between exchange rate and
inflation. The study recommends that
Model: Ordinary monetary policy alone should not be used to
Least Squares (OLS) control inflation but fiscal and other non-
monetary measures must be employed.
10 Mishra and Various countries This paper surveys the Various papers Monetary transmission depends crucially on
Montiel (How effective is evidence on the each economy's financial structure. The
(2013) monetary effectiveness of Model: Theoretical financial structure of low-income countries
transmission in monetary and empirical (LICs) is such that several conventional
low-income transmission in review of the channels of transmission are likely to be weak
countries? A developing countries. literature or non-existent. There is little VAR-based
survey of the evidence of powerful and reliable monetary
empirical transmission in LICs, regardless of the
evidence.) identification schemes used by researchers. If
the results hold up, however, a fundamental
rethinking of the roles of central banks in
these economies may be called for.
11 Ribon (2011) Israel (The Effect The paper studied the Monthly data (1997 Results of the study showed that most prices
of Monetary effect of monetary to 2010). Derived decline in response to an increase in the
Policy on policy on the Israeli factors from 106 interest rate, so there is no "price puzzle".
Inflation: A consumer price index monthly indicators Further, a shock to the interest rate has, at
Factor and its for real activity, least for some time, an effect on relative
Augmented VAR components using a labour market data – prices due to a distinct effect on partial price
Approach using Factor Augmented employment and aggregates of the CPI. Finally, a shock to the
disaggregated VAR approach. nominal and real exchange rate (depreciation) has a positive
data.) wages, CPI data, effect on all prices with prices of traded
market-based goods, energy and
inflation housing increasing more than other prices.
expectations,
monetary
aggregates and
different yields.
Other variables
included US
production index, a
commodity price
index, oil prices and
the Fed's interest
rate.

Model: Factor
Augmented VAR
(FAVAR)
12 Rasche and Various countries The analysis 1990 to 2006 Inflation targeting central banks appear to
Williams, (The addressed changing have an admirable record of consistently
2005 Effectiveness of views of the role and Model: Country hitting targets on a “medium run” horizon.
Monetary Policy.) effectiveness of comparisons However, it is not clear what the marginal
monetary policy, contribution of inflation targeting beyond a
inflation targeting as credible commitment to price stability is.
an “effective monetary
policy,” monetary
policy and short-run
(output) stabilization,
and problems in
implementing a short-
run stabilization
policy.
Studies on monetary policy effectiveness in Zambia
13 Patrick and Zambia (The The study sought to Monthly data (1993 Results indicated that the exchange rate and
Akanbi Relative examine relative to 2015): credit are effective channels of monetary
(2017) Importance of the importance of endogenous policy transmission in Zambia. Further, the
Channels of different channels of variables are output study shows that although the interest
Monetary Policy the monetary (Real GDP), channel is working it is weak while the equity
Transmission in a transmission Consumer Price or asset price channel is not important.
Developing mechanism in Zambia. Index (CPI), Broad
Country: The Money (M2), and
Case of Zambia.) Short-Term Interest
rate (BoZ Policy
Rate) while the
exogenous variables
were the copper
price (Cupr), Oil
Price (Oilpr), and
 the Federal Funds
Rate (FFR).

Model: Vector
Autoregressive with
exogenous variables
(VARX) Methods.
14 Mwafulirwa, Zambia Reviewed the Quarterly data Money supply was more responsive to
2017 (Estimating effectiveness of (2000 to 2016): inflation gap than the policy rate and hence is
Effectiveness of monetary policy in Policy rate, money a more effective policy instrument. Though
Monetary Policy Zambia using supply (M2), both policy rate and money supply can reduce
in Zambia Using monetary response exchange rate, the inflation gap, policy rate is biased towards
Monetary functions based on output gap, inflation output stabilization.
Response two policy gap
Function). instruments i.e., Policy
Rate and Money Model: Vector
Supply. Autoregressive
model
15 Haabazoka Zambia (A study Assessed the Monthly data (2012 Policy rate was ineffective as a policy tool to
and of the effectiveness of the to 2014): Policy rate, manage inflation as any variations in the
Nanchengwa, Effectiveness of Bank of Zambia Policy exchange rate, price level were already explained by changes
2016 the Monetary Rate in maintaining inflation. in the exchange rates
Policy Rate as a favourable inflation
Tool levels in Zambia. Model: A 2-stage
of Inflation linear regression
Control in analysis.
Zambia)
16 Zgambo and Zambia Provided empirical Quarterly data Monetary aggregates (broad money) and the
Chileshe, (Empirical analysis of the (1995:1-2014): real exchange rate are important variables for
2014 Analysis of the effectiveness of GDP, nominal monetary policy transmission, interest rates
Effectiveness of monetary policy in exchange rate, 91- had no significant effects on output and
Monetary Policy Zambia by day Treasury bill prices.
in Zambia) investigating the rate, money supply
money demand (M2), Inflation, CPI,
function and the copper prices, crude
monetary oil prices, and the US
transmission Federal Funds rate.
mechanisms
Model:
Autoregressive
Distributed Lag
(ARDL) and Vector
Autoregressive
(VAR) framework
17 Hangoma Zambia Assessed the Annual data (1992 Found that inflation in Zambia is demand
(2010) (Appropriateness applicability of the to 2008): inflation, driven and supply side factors are
of inflation inflation targetting short term interest insignificant. The main policy implication of
targeting as framework by rate, output gap, the results is that inflation targeting can be
monetary policy investigating the fiscal deficit, money adopted but serious attention has to be given
framework for factors that drive supply (M2), to the interest rate that will be employed.
Zambia) inflation. domestic oil price,
earnings, fertilizer
prices, nominal
excess demand
growth, nominal
aggregate supply
growth, real
effective exchange
rate.

Model: OLS
estimation of
inflation targeting
models by
Svensson(1997) and
Chand and Singh
(2006)
 Strand 2: Research works that control for the effects of exogenous variables within endogenous models, also known as the VECX*
models
18 de Waal and South Africa Developed a model for Quarterly data The lag between a change in the repo rate and
van Eyden (Monetary Policy examining (1979 to 2009): real the full impact on inflation is around 24
(2014) and Inflation in transmission of output, inflation, months. The VECX* model,
South Africa: monetary policy repo rate, long-term thus, shows the effective transmission of
A VECM changes to inflation in interest rate, real monetary policy in South Africa between
Augmented with South Africa. exchange rate, 1979 and 2009.
Foreign foreign real output,
Variables) foreign prices,
foreign short-term
interest rate and the
oil price.

Model: Structural
cointegrated vector
autoregressive
(VAR) model
19 Assenmacher- Switzerland (A Developed a long-run quarterly data Model can be used to produce forecasts for
Wesche and VECX model of structural (1976 to 2006): M2, the endogenous variables either under
Pesaran, 2008 the Swiss cointegrating VAR real GDP, the three- alternative specifications of the marginal
economy) model that relates core month LIBOR rate, model for the exogenous variables, or
macroeconomic inflation, nominal conditional on some pre-specified path of
variables of the Swiss exchange rate, the those variables (for scenario forecasting).
economy to current ratio of the domestic
and lagged values of to the foreign price
several key foreign level, foreign real
variables GDP, foreign three-
month interest rate,
and the oil price.

Model: Structural
cointegrating VAR
model
20 Garratt et al., United Kingdom Discusses the Quarterly data The SVAR has attractive features and the
2003 (A structural structural (1965 – 1995): embedded long run relations are theory
cointegrating cointegrated VAR and output, domestic consistent with clear interpretation
VAR approach to compare it to other price, nominal economically.
macro existing models interest rate,
econometric exchange rate,
modelling). money supply,
foreign output,
foreign nominal
interest rates,
foreign price level
and oil prices.

Model: Structural
cointegrating VAR
model
Strand 3: research works that have concentrated on determinants of inflation and inflation dynamics
21 Chipili, 2021 Zambia (Inflation Assessed the empirical Quarterly data Long-run sources of inflation in Zambia
Dynamics in drivers of inflation in (1994-2019): include the exchange rate and world non-
Zambia) Zambia inflation, nominal food prices. In the short-run, overall inflation
exchange rate, is determined by movements in the exchange
money supply, rate, energy (diesel) price adjustments,
copper prices, imported inflation and supply constraints
energy (diesel) (changes in maize prices).
prices, real GDP, Food and non-food inflation exhibit different
world food prices, characteristic behaviour with food inflation
world non-food exhibiting seasonality.
prices, US Treasury
bill yield rate

Model: Single-error
correction model
22 Nguyen et al., SSA (On the Analysed the inflation Quarterly data Supply shocks explain about 45 percent of
2017 drivers of dynamics in SSA (1988-2013): CPI, inflation fluctuations in the region on
 inflation in Sub- nominal effective average, a third of which reflect shocks to
Saharan Africa) exchange rate, global commodity prices and spillovers from
broad money, other countries, and the other two-thirds
nominal interest reflect country-specific supply shocks to
rate (deposit or inflation. Domestic demand pressures play a
discount rate), real larger role in influencing inflation.
GDP, global oil and
food prices

Model: Global VAR

model
23 Mohanty and India Identified the Quarterly data The impact of changes in crude oil prices on
John, 2015 (Determinants of determinants of (1996-2014): inflation is immediate and peaks in the first
inflation in India) inflation in India inflation, domestic quarter. Fiscal and monetary policies impact
crude oil prices, inflation with about 4 lags while the output
output gap, fiscal gap was insignificant.
deficit, overnight
weighted average
call money rate
(monetary policy)

Model: Structural
VAR model
24 Lim and Sek 28 countries (An Examined factors Annual data (1970 – GDP growth and imports of goods and
(2015) Examination on affecting inflation in 2011): inflation, services have significant long run impact on
the Determinants two groups of money supply, inflation in low inflation countries. Money
of Inflation) countries (high national supply, national expenditure and GDP growth
inflation group and expenditure, are the main determinants of inflation in high
low inflation imports of goods inflation countries. In the short run likewise,
group) and services and none of the variables are found to be
GDP growth. significant determinants in high inflation
countries. However, money supply, imports
Model: An Error of goods and services and GDP growth has
Correction Model significant relationship with inflation in low
based on the inflation countries.
Autoregressive
Distributed Lag
(ARDL) modelling
25 Adu and Determinants of Provided an empirical 1960-2009: Real output, nominal exchange rate, broad
Marbuah Inflation in analysis of the factors Real GDP, exchange money supply, nominal interest rate and
(2011) Ghana: An accounting for rate, money supply fiscal deficit play a dominant role in the
Empirical inflation dynamics in M1, M2 and M2+, inflationary process in Ghana. Output growth
Investigation Ghana interest rate, fiscal has the strongest impact on inflation, so
deficit, CPI targeting supply-side constraints will help
moderate price inflation.
Model: ARDL model,
long run multipliers
by semi-parametric
fully modified least
squares (FMOLS)
and dynamic
ordinary least
squares estimator
due to Phillips and
Hansen (1990) and
Stock and Watson
(1993), respectively.
26 Laryea and Determinants of Developed an Quarterly data Monetary factors main determinants, and to a
Sumaila inflation in econometric model to (1992 – 1998); CPI, lesser extent by volatility in output or
(2001) Tanzania examine the major M1, M2, exchange depreciation of the exchange rate. In the short
determinants of rate and output run, output and monetary factors are key but
inflation in Tanzania (GDP) in the long run, the parallel exchange rate also
plays a key role, in addition to output and
Model: Derive a money.
model theoretically,
then estimate it
using OLS. Also use
 an error-correction
framework.
27 Cottarelli 47 countries: 22 Assessed the Annual data (1993 – There is a significant effect of fiscal deficits on
(1998) industrialized significance of various 1996) four data sets: inflation, particularly (but not exclusively) in
OECD countries, nonmonetary factors (1) all countries - countries where the government securities
10 countries that have been thought current account, market is not well developed. Other factors
from Central and to determine inflation. fiscal deficit, with significant effect on inflation include
Eastern Europe, exchange rate relative price changes, central bank
and 15 countries regime, degree of independence, the exchange rate regime, and
from the Former openness, results of the degree of price liberalization; there is only
Soviet Union IMF questionnaire limited evidence that other structural factors,
(The non- and government such as those influencing the natural rate of
monetary domestic debt. unemployment, have a significant effect on
determinant of (2) G40 data set – inflation.
inflation – a panel also included
study). unemployment rate
and base money.
(3) G18 data set -
also contains a
measure of relative
prices but only for
18 transition
economies for the
period 1993–95.
(4) also has seven
structural indicators
of private sector
share in GDP; large-
and small-scale
privatization;
enterprise
restructuring;
degree of price
liberalization; trade
and exchange
system reform; and
a measure of
banking sector
reform.

Model: dynamic
panel data
estimation
techniques use a
modified version of
the Arellano and
Bond estimator
suggested
by Pesaran
(1997) which
employs the
seemingly unrelated
regression
equations (SURE)
technique
28 Moser (1995) Nigeria (The Analysed the main (1960-1993): Broad Monetary expansion, driven mainly by
Main factors which money, exchange expansionary fiscal policies, explains to a
Determinants of influenced inflation rate, nominal large degree the inflationary process in
Inflation in foreign interest Nigeria. Other important factors are the
Nigeria) rates, inflation, devaluation of the naira and agroclimatic
foreign prices, conditions. It was found that concur rent
rainfall fiscal and monetary policies had a major
influence on the impact of the depreciation of
Model: An error the naira.
correction model