Applied Economics Letters

ISSN: 1350-4851 (Print) 1466-4291 (Online) Journal homepage: https://www.tandfonline.com/loi/rael20

Divisia monetary aggregate and monetary

transmission mechanism in the Democratic
Republic of Congo (DRC)

B.P. Yemba, B. Tang, E Kitenge & J. Nsumbu

To cite this article: B.P. Yemba, B. Tang, E Kitenge & J. Nsumbu (2019): Divisia monetary
aggregate and monetary transmission mechanism in the Democratic Republic of Congo (DRC),
Applied Economics Letters, DOI: 10.1080/13504851.2019.1613498

To link to this article: https://doi.org/10.1080/13504851.2019.1613498

Published online: 12 May 2019.

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APPLIED ECONOMICS LETTERS
https://doi.org/10.1080/13504851.2019.1613498

ARTICLE

Divisia monetary aggregate and monetary transmission mechanism in the

Democratic Republic of Congo (DRC)
B.P. Yembaa, B. Tangb, E Kitengec and J. Nsumbud
a
Division of Finance and Economics, Marshall University, Huntington, USA; bDepartment of Economics, University of Massachusetts
Dartmouth, New Bedford, USA; cDepartment of Business Administration, College of Business, Central State University, Wilberforce, OH, USA;
d
Department of Economics, Faculty of Economics and Development, Catholic University of Congo, Kinshasa, Democratic Republic of Congo

ABSTRACT KEYWORDS
While the majority on the effectiveness of monetary policies focus on either interest or money channels, Monetary policy; divisia
we analyze the effectiveness of a composite monetary instrument: The Divisia Aggregate Index (DMAI). monetary aggregates;
Dynamic effects of the DMAI on other economic factors is analyzed through the Factor Augmented FAVAR; monetary
transmission mechanisms
Vector Autoregressive model (FAVAR). The latter address the potential arbitrary selection of variables to
incorporate in a standard VAR model, and is built from the ability of factor analysis to summarize a very JEL CLASSIFICATION
high number of variables into few factors. The FAVAR is applied to monthly data over the period C3; E4; E51; E52; E59; F31;
01:1996-12:2017 from the Democratic Republic of the Congo. Our empirical results reveal that the DMAI F41
outperforms other monetary policy instruments that use separately interest or money channels, in
boosting output and triggering price stability.

I. Introduction
1
This paper analyses the effectiveness in impacting
both output and inflation, of the Divisia Monetary
Aggregates Index (DMAI) compared to other instru-
ments in the Democratic Republic of the Congo
(DRC)’s monetary transmission mechanisms. While
monetary authorities in DRC mainly employ interest
rate or money channels to achieve price stability, the
effectiveness of these channels is sometimes ques-
tioned. In most of South Saharan Africa (SSA) coun-
tries, the literature reveals that interest rate channels
are relatively ineffective compared to money channels
(Davoodi, Dixit, and Pinter 2013; Baldini and
Poplawski-Ribeiro 2011; Mishra, Montiel, and
Spilimbergo 2012). Meanwhile, the literature on
monetary policy and especially on MTM in DRC is
remarkable lacking. And existing literature suggests
that fiscal policy acts as the dominant stabilization
policy due to the ineffectiveness of the monetary
policy conducted by the Central Bank of Congo
(BCC). It also suggests strong and statistically signifi-
cant long-term relationships between budget deficits
and money growth, money creation and inflation
(Nachega 2005). Thus, this paper will provide more
insights into the possibility for the DRC to enhance
the effectiveness of monetary policy by using
a composite instrument (DMAI) instead of individual
interest rate or money instruments.
The effectiveness of monetary policy instruments
has attracted many scholars’ attention. It is revealed
that the development of financial markets is critical
for the effectiveness of interest rate channels in the
transmission of monetary policies (Boivin, Giannoni,
and Stevanovic 2010; Mishra and Montiel 2013).
Moreover, Belongia and Ireland (2012) showed that
movements in both quantity and price indices for
monetary assets correlate strongly with movements
in output. Therefore, the effectiveness of monetary
policy will depend not only on factors such as financial
markets but also on the policy instruments.
The choice and measurement of policy instruments
are critical for the effectiveness of monetary policy.
Most of the central banks in SSA use the ‘simple sum’
money supply, M2, which adds the nominal values
(quantities) of monetary assets together (Davoodi
et al. 2013). The simple sum money supply does not
consider the degree of ‘moneyness’2 or liquidity of
different monetary assets and overstate significantly

CONTACT B. Tang btang@umassd.edu Department of Economics, University of Massachusetts Dartmouth, New Bedford, USA
1
A policy instrument is effective when it helps the central bank to achieves its policy goals (output growth and price stability).
2
Money-ness measures the liquidity of monetary assets. Currency and coin are the most liquid (hundred percent liquid) and other monetary assets are not
hundred percent liquid.
© 2019 Informa UK Limited, trading as Taylor & Francis Group
2 B. P. YEMBA ET AL.

the money stock (Barnett and Chang 2006). The observational and unobservable errors, respec-
alternative measure of money, the DMAI, proposed tively, and innovations that are linear combina-
by Barnett (1980), has the advantage over ‘simple sum’ tions of the structural macroeconomic shocks
since it considers both the prices3 (foregone interest (e.g. monetary policy shock). 
0 0
rates) and quantities of monetary assets’ liquidity ser- Assume the joint dynamics of Ft ; Yt are given
vices (money aggregate). by the following transition equation
Our empirical results reveal that the DMAI


instruments affect both output and inflation Ft Ft1
¼ ΦðLÞ þ et (2:2)
while the other monetary instruments (e.g. simple Yt Yt1
sum M2, the director interest rate, and the nom-
inal exchange rate) affect mostly only inflation. where ΦðLÞ is the coefficients vector of a lag poly-
Our finding concurs with Belongia and Ireland nomial of finite order, and εt ,N ð0; ΩÞ. The equa-
(2012) who asserted that standard models and tion 2.2 represents the VAR within the model,
policy discussions suffer an important omission equation 2.1 and 2.2 comprise the Factor-
which can be mitigated using appropriate mea- Augmented Vector Autoregressive model.
sures of monetary aggregates such as the DMAI. 0 Z 1
t
B Pt C
B  C  0
B R C
II. Model and data Yt ¼ B t C and E εt εt ¼ Ω is the diagonal
B Zt C
@ A
Our FAVAR follows the general specification pro- Pt
posed by Bernanke, Boivin, and Eliesz (2005) and MPIt
the extension to the small open economy by covariance matrix of structural shocks.
Boivin, Giannoni, and Stevanovic (2010). We use Zt denotes the US GDP growth Rate, Pt
two blocks of variables: the world (*) and domes- denotes the Nasdaq’s copper price index,4denotes
tic. The observable general form is: the Fed Fund Rate, Zt denotes the Congolese GDP
growth Rate, Pt denotes the Congolese inflation
Xt ¼ Γf Ft þ Γy Yt þ vt (2:1)

 rate, and MPIt denotes the monetary policy instru-
ε ment. The choice of variables follows Boivin,
Where vt ¼ t is the (Nx1) vector of error
εt Giannoni, and Stevanovic (2010)’s paper. In this
terms assumed to be uncorrelated with paper, we explore the following instruments:
 0 0
Ft ; Yt at all leads and lags. Xt is an N x 1 Divisia M2 growth rate (DM2t ), director rate of
vector of observable economic indicators BCC (DRt ), simple sum M2 growth rate (M2t ),
where the number of series, N, is assumed to and nominal exchange Rate(NERt ).
be much larger than the number of unobserva- The data set is a panel data of 56 monthly series
ble factors in Ft , K, and the number of elements from 1996:01 to 2017:12. We assume that anticipated
in Yt , M. The unobservable factors in DRC and shocks to the monetary policy instrument affect only
the rest of the world capture fluctuations of key the domestic variables (Zt ; Pt ) with lag, and they do
objectives of monetary policy. Some of these not affect the world variables (Zt ; Pt ; andRt Þ. In con-
objectives can be observable contempora- trast, policy instruments are allowed to respond to
neously by the central bank but may be tech- shocks from other variables immediately. The order
nically difficult to include in Yt from the of the variables follows the recursive standard fashion,
regular VAR. Γf is an (N x K) matrix of factor and the innovations of the model are monetary policy
loadings. Γy is an (N x M) matrix of loadings shocks. This ordering imposes the identifying
relating the observable factors in Yt and Xt . assumption that the latent factors do not respond to
εt and εt are N × 1 vectors of specific monetary shocks within the first three months.

3
Prices of monetary assets are measured by the user costs or the opportunity costs of holding the asset for its liquidity services rather than investing it to
obtain a much higher interest rate (Barnett 1980).
4
Congolese economy depends mostly on its copper export.
 APPLIED ECONOMICS LETTERS 3

Figure 1. Impulse response functions to divisia M2 growth shock.

This model has the merit of solving the omitted III. Results
variables bias associated with the traditional VAR
The effectiveness of the monetary policy depends on
and eliminates the liquidity, price, and forward
the accurate measurement of impacts or sensitivity
discount bias puzzles.5 We use these anomalies
of policy instrument variables, on the change of
as the robustness of our findings.
monetary policy objective variables (inflation,

5
The price puzzle occurs when the monetary policy shocks are identified as innovations in interest rates, an increase in the interest rate is associated with a persistent
increase, rather than a decrease of the price level. The liquidity puzzle occurs when there is a positive shock to the monetary aggregates, the increase in monetary
aggregates is associated with increases rather than decreases in nominal interest rates. The forward discount bias occurs when a positive shock in domestic interest
rate relative to a foreign one is associated with a persistent appreciation, rather than depreciation, of the domestic currency for periods up to two years after the initial
shock.
4 B. P. YEMBA ET AL.
unemployment rate, and growth rate of GDP).
Therefore, the estimated impulse response functions
(IRF) on the policy instrument variables are inter-
preted as the sensitivity of that variable to both policy
objective variables and the changes in sensitivity are
suggestive of changes in the transmission of monetary
policy (Boivin, Giannoni, and Stevanovic 2010).
Figure 1 shows the effectiveness of DMAI in
impacting both output and inflation. Accordingly, a
positive shock of Divisia M2 growth rate is associated
with an increase in inflation, a persistent increase in
Figure 2. Impulse response functions to M2 growth shock.
the GDP growth rate. This shock is also associated
with a persistent decrease in the nominal interest rate,
which shows that the liquidity puzzle is solved.
Figure 2 shows that M2 impact only on inflation.
Accordingly, a positive shock of the simple sum M2
growth rate has no significant impact on the growth
rate of GDP, an immediate and short positive impact
on inflation, and a negative impact on the nominal
interest rate (Interbank interest rate). So, the liquidity
puzzle is solved, and this instrument leaves the output
insensitive.

Figure 3 shows that the interest rate impact
only inflation. Accordingly, a positive shock of
the interest rate is associated with a sudden and
short increase in inflation, insignificant and almost
zero impact on the growth rate of real GDP,
a negative impact on the price level, and deprecia-
tion of Congolese Franc relative to the US dollar.
Therefore, the price and forward discount bias
puzzles are solved, this instrument is not as effec-
tive as the DMAI since it leaves the output
insensitive.
Figure 4 shows that the nominal exchange rate
impacts only inflation. Accordingly, a positive shock
of the nominal exchange rate has no effect on the
Figure 3. Impulse response functions to nominal director rate shock.
APPLIED ECONOMICS LETTERS 5
growth rate of real GDP for the entire period;
a negative impact on inflation, and price level.
IV. Conclusions
This paper concludes that: 1) DMAI is an effective
monetary instrument available for Congolese central
bank to improves the conduct of monetary policy by
abandoning the nominal director rate and simple sum
M2; 2) Divisia M2 index as monetary instrument
outperforms all other instruments (simple sum M2,
director rate of BCC, and nominal exchange rate). In
fact, it is the only instrument that affect both output
growth and inflation. Since the Congolese economy is
6 B. P. YEMBA ET AL.
Figure 4. Impulse response functions to nominal exchange rate shock.
a small open economy, the puzzles mentioned above
disappear in our results which indicates that they are
not only robust but also consistent with the literature
on FAVAR. Therefore, we propose the DMAI as an
effective instrument for the BCC to enhance the con-
duct of monetary policy.
Disclosure statement
No potential conflict of interest was reported by the
authors.
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