Investigating The Effectiveness Of Transmission Mechanisms Of Monetary Policy In Sierra Leone

ABSTRACT

Investigating the effectiveness of transmission mechanisms of monetary policy is crucial for an economy. It is essential to understand how effectiveness the channels of transmission are in affecting economic activity. This study investigates the effectiveness of transmission mechanisms of monetary policy in Sierra Leone with particular focus on the interest rate, exchange rate, and credit channels. It used a Vector Autoregression (VAR) approach to estimate time series annual data from 1980 to 2012. The study employed techniques such as unit root tests, cointegration, Granger causality test, impulse responses and variance decomposition. The cointegration test result revealed that cointegration exists. The Granger causality test showed that gross capital formation Granger causes exchange rate and real interest rate. The impulse response function showed that output responded positively to monetary shocks, as interest rate increased. Output increased for a short period and then declined. In the case of exchange rate and private domestic credit, output showed that even in the long run, the effects of the shocks might not be transitory in order to converge towards a steady state. The variance decomposition indicated that fluctuations in gross domestic product per capita (GDPPC) were attributed to itself. While the total contribution of real interest rate (RIR) and exchange rate (ER) was relatively insignificant. The error forecast of RIR was attributed by itself with an insignificant contribution of GDPPC and none by ER and private domestic credit (PDC). Fluctuations in forecasting ER were greatly attributed to itself and trivial contributions by the other variables. The error forecast of PDC was greatly dominated by itself. As the trend fell, there was a slight increase in the contribution of the other variables. The results provided evidence of ineffective channels in the Sierra Leone economy.