MONETARY POLICY STRATEGY IN RWANDA
Serge Musana Mukunzi
Supervisor: Nicola Viegi
Submitted in partial fulfillment of the requirements for the
Master's degree of commerce (Economics).
University of Kwazulu-Natal,
I declare that this is my own work, except where acknowledged
in the text, and has been submitted or a degree at any other university.
TABLE OF CONTENTS
Chapter 2: THEORETHICAL FOUNDATION OF MONETARY
2.1: Objective of monetary
2.2: The instruments of monetary
2.3: Monetary policy
2.3.1: Choosing and using a
2.3.2: Monetary policy
188.8.131.52: Exchange rate
184.108.40.206: Money supply
220.127.116.11: Nominal GDP target
18.104.22.168: Inflation targeting
Chapter 3: MONETARY POLICY IN
3.2: Monetary and exchange rate policy
3.2.2: Exchange rate
Chapter 4: ILLUSTRATION OF MONETARY STRATEGY
BY MEANS OF
4.1.1: Reaction function for
22.214.171.124 Time series properties of the
Chapter5: CONCLUSION AND
LISTE OF TABLES
Table 3.1: Inflation objective and
Inflation observed in
Table 3.2 Monetary stock aggregate(M2) Net External Asset
Net Interior Asset (NIA)In
Table 4.1 Unit root test-levels of
Table 4.2 Unit root tests of the first
Table 4.3 Ordinary Least squares
estimation of equation
Table 4.4 Ordinary Least squares
Estimation of equation
LISTE OF FIGURES
Figure 3.1: Annual growth of monetary stock aggregate
This dissertation is dedicated to the Musana family.
My thanks goes to my academic supervisor Dr Nicola Viegi for
his guidance, inspiration, comments and criticism which inspired many ideas and
produced some very satisfying solutions.
I have profound gratitude to Professor Rwigamba Balinda, the
Rector of Kigali Independent University, for sponsoring my post graduate
studies at the University of Kwazulu-Natal.
Thanks goes to my friends and colleagues in the economic
department for making my student life enjoyable.
Thanks also goes to my family and all friends for their
encouragement and support which they have given me during my studies.
Last but not least, special thanks goes to my Lord Jesus
Christ for all the Blessings, which, I enjoy in this life.
The aim of this dissertation is to study how monetary policy
is conducted in Rwanda. The task has been accomplished by designing and
estimating a Taylor rule, monetary policy reaction function for the National
Bank of Rwanda over the period 1997-2001.
Applying Ordinary Least Squared (OLS) on the time series data,
we test whether the Central Bank in Rwanda reacts to changes in the inflation
gap, the output gap and the exchange rate. The results of the study show that
the Central Bank of Rwanda has had a monetary policy over the years with the
monetary stock aggregate (M1) as the principal instrument. The results also
show that the Central Bank of Rwanda reacted by giving much importance to the
exchange rate than to inflation and neglected the output.
CHAPTER 1: INTRODUCTION
In recent years, Central Banks appear to have conducted
prudent monetary policies in several countries. In such a context, the role of
monetary policy as a stabilisation policy is becoming more powerful and well
determined. As argued in Blinder (1998), Central Banks have never been more
powerful than now. Monetary policy has become the principal means of
macroeconomic stabilisation, and in most countries it is entrusted with the
responsibility of an independent Central Bank.
From the experience of developed economies in the world which
exhibit strong economic management, various countries in developing economies
have undertaken economic reforms consisting essentially of a set of
market-oriented economic policies intended to readjust the economy to the
liberalisation as well as bringing about an institutional reorganisation.
In the sub-Sahara African context, reforms increased
significantly in the 1990s. The broad strategy has been the emphasis placed on
the policy programs supported by the International Monetary Fund (IMF) and the
World Bank, including among others fiscal reforms, liberation of exchange
restriction and the adoption of indirect instrument of monetary policy,
market-based interest policies, and so on. (IMF, December 2000).
Rwanda is no exception to this situation. Rwanda's economy is
very small and open, heavily reliant on the export of few major products,
especially coffee and tea. In addition it is also very reliant on imports for
most of its consumables.
The destruction of the economic base that took place during
the civil war period (1990-1994) forced the authorities to begin a process of
economic liberalisation: to turn away from the situation of control, regulation
and state command and turn towards more market related policies since 1994. In
1997, Rwanda embarked on a program of sustainable economic growth. A revised
Central Bank statute underpinning the National Bank of Rwanda's independence in
conducting the country's monetary policy was adopted. The period of
1998/99-2000/2001 was characterized by an enhanced structural adjustment
facility program supported by IMF and World Bank. Based on this strategy, the
macroeconomic objectives included an annual average real Gross Domestic Product
(GDP) growth of 8 percent a year during the period 1998-2000; and a reduction
in inflation to 5 percent by end 1999. In the period 1999-2002, the
macroeconomic objectives were to achieve an annual real GDP growth of 6%, while
keeping inflation at or below 3%.
In such program, the monetary policy played a central role in
producing macroeconomic stability. It stated that monetary and credit policies
would aim at further reducing the rate of inflation, and the authorities would
continue to monitor development in both reserve money and broad money closely
(IMF and Rwanda 1995/2002).
What it is clear from the Rwandan Central Bank behavior is
that an achievement of the inflation target seems to be a fundamental goal of
the monetary authority. On the basis of all the macroeconomic objectives
mentioned above, Rwandan monetary authorities seem to assess the performance of
monetary policy rules in terms of their effect on inflation and output. Such an
assessment can be based on a situation in which the Central Bank refers to an
equation, which is intended to establish the goal that has actually been
influencing the actions of the Central Bank. One could interpret such behavior
as being approximated by a particular rule referred to as the Taylor rule. In
such a rule, monetary policy is adjusted in response to the deviation of
inflation from its target value and the deviation of output from potential.
More than five years have passed since the monetary policy
was given a central role in maintaining macroeconomic stability and a new
statute has provided rule for monetary policy objectives and Central Bank
independence. Enough observations have become available to perform an
assessment of the Rwanda Central Bank's conduct of monetary policy based on
choosing a rule and then using a model of the economy to examine how the
economy would have behaved under the rule.
The objective of the thesis is thus, to attempt to
approximate the policy behavior of the Rwanda Central Bank by estimating a
variant of the Taylor rule for Rwanda. In this specific model, the dependent
variable is the monetary base that the Central Bank is assumed to control,
while the explanatory variables are those that are assumed to affect Rwanda
Central Bank's behavior. By attempting to measure the policy behavior, the
question that arises is what was the Central Bank really reacting to? Or in
other words, which targets did the Central bank actually follow?
More specifically, the study aims to:
- Review the literature on the theoretical foundation of
monetary policy: examining the process of monetary policy and describing
monetary policy strategies
- Examine the conduct of monetary policy in Rwanda
- Describe the monetary policy strategy in Rwanda by means of
a model. That is, a Taylor Rule monetary policy reaction function applied to
Rwanda and to interpret the estimated results in the context of the Rwandan
The Taylor Rule has been considered as a representation of
Central Bank behavior in various countries. It provides information about the
responsiveness of the monetary policy instrument to the monetary variables.
Therefore, estimating the policy behavior of the Rwanda Central Bank and
determining the target the Central Bank followed, is essential to the different
policy implications, especially to the implementation of an accurate and
successful monetary policy.
The structure of the study is as follows:
Chapter 1 is an introduction. Chapter 2 presents the
theoretical foundation of monetary policy and describes the process of monetary
policy and monetary policy strategies focusing on the discussion about the main
rules for monetary policy. Chapter 3 presents the monetary policy in Rwanda and
describes the way the National Bank of Rwanda formulates and carries out its
monetary policy. It also shows exchange policy management and its relationship
to the monetary policy. Chapter 4 presents an illustration of the monetary
policy strategy by means of a model and focuses on estimating a Taylor-type
monetary reaction function for Rwanda. This chapter also covers the
methodology, including the estimation results and its analysis. Finally in
chapter 5, a conclusion and suggestion are provided.
CHAPTER 2: THEORETICAL FOUNDATION OF MONETARY
2.1 THE OBJECTIVES OF MONETARY POLICY
Broadly speaking, the objective of monetary policy is to
influence the performance of the economy as reflected in factors such as
inflation, economic output and employment. It works by affecting demand across
the economy in terms of people and firms willingness to spend on good and
services (Federal Reserve Bank of San Francisco, 2004).
In such context, the main goal of any monetary policy is to
maintain stability in the broadest sense. Wallich (1982: 45) explained that by
helping to promote price stability and to avoid recession monetary policy
contributes to a framework within which the market can operate with greater
confidence. According to Mishkin (1997) six basic goals are continually
mentioned by Central Banks when they discuss the objective of monetary
- High employment level
- Economic growth
- Price stability
- Interest- rate stability
- Stability of financial markets
- Stability in foreign exchange rate markets.
In general, a high employment level has a strong link with a
sustainable output and this relationship makes the employment an important
objective. Indeed, it can be considered that when unemployment is high,
resources and workers are not sufficiently used in the economy and this results
in a low output.
The goal of economic growth is related to the one of
employment. Indeed, the economy is characterised by business cycles in which
output and employment are above or below their long term levels. The role of
monetary policy consists of affecting the output and the employment in the
short term. For example, when demand weakens and there is a recession, the
Central Bank can stimulate the economy temporarily and help push it back toward
its long term level of output by lowering interest rates.
The goal of price stability is also most desirable. This can
just be illustrated by the fact that persistent attempts to expand the economy
beyond its long term growth path will result in capacity constraints and will
lead to higher inflation without lowering unemployment or increasing output in
the long term (Federal Reserve Bank of San Francisco, 2004). Dornbusch, Fisher
and Startz (2001) show in the same way how the costs of high inflation are easy
to see: in countries where prices increase all the time, money no longer a
useful medium of exchange, and sometimes output drops dramatically.
According to Mishkin (1997: 476), the goal of interest-rate
stability, stability of financial markets and stability in foreign exchange
markets can be shown in short as the following:
Interest- rate stability is important because fluctuations in
interest rates can lead to uncertainty in the economic environment and disrupt
the plan for the future. Concerning the stability of financial markets, it is
known that financial crises can interfere with the ability of financial markets
to channel funds to people with productive investment opportunities, resulting
in a sharp reduction in economic activity. Having a stable financial system in
which financial crises are avoided is an important goal for a Central Bank.
Finally, the stability in foreign exchange markets has become
a major consideration of the Central Bank given the increase in international
trade and the increase in international integration.
Not all of those goals can be pursued by a given Central Bank.
Each one has to choose which goals they consider most important and vital to
their economic realities. However, when Central Banks have to decide about
which specific objectives to adopt, some conflicts among goals create veritable
difficulties. Mishkin (1997) explains that although many of the goals mentioned
are consistent with each other, this is not always the case. The goal of price
stability often conflicts with the goals of interest-rate stability and high
employment in the short term.
When all these bank's objectives are decided upon, the next
question becomes what instruments or tools does the Central Bank need to put
into operation and how useful are these tools?
2.2 THE INSTRUMENTS OF MONETARY POLICY
After selecting monetary policy objectives, Central Banks make
use of various monetary policy instruments at their disposal. Fundamentally
these instruments allow the Central Bank to stimulate or slow down the economy
by influencing the quantity of money and credit the banks can provide to their
customers through loans. Two types of monetary instruments are generally
classified, namely indirect and direct policy.
According Gidlow (1998), the indirect policies are considered
to be actions taken by the Central Bank whereby it achieves its monetary policy
aims by encouraging market participants to take particular actions in terms of
their lending and borrowing behavior. These actions may be the result of price
and interest rate incentives or disincentives brought about in the financial
market. The direct policy instruments on the other hand refer to the measures
taken by Central Bank that seek to attain the aims of monetary policy by means
of certain rules prescribing the behavior pattern of banks and possibly other
financial institutions. The indirect instrument is also considered as
market-oriented whereas the direct instrument is a non-market-oriented. Meyer
(1980) agreed that monetary policy instruments are generally classified as
either general or selective controls. General controls have their primary
effect on either the net monetary base or the size of the money multiplier.
These include open market operations, changes in reserve requirements, and
changes in the discount rate. Selective controls on the other hand, have their
primary influence on the allocation of credit among alternative uses. The
examples of selective controls include margin (or down payment) requirements
for loans to acquire securities and interest rate ceilings on rates paid by
banks on savings accounts or charged by banks on loans. Gidlow (1998) provided
as an example of direct policy instruments, the case of instructions sent to
banks under which the latter are requested not to exceed a certain amount of
lending to domestic private sector borrowers as specified period, and
instructions that banks must not quote interest rates above or below a certain
maximum or minimum level on their various credit and deposit facilities made
available to customers. Alexander et al (1995:14) also provided an interesting
explanation about direct and indirect policy instruments. They showed that the
term «direct» refers to the one- to one correspondence between the
instrument (such as credit ceiling) and the policy objective (such as a
specific amount of domestic credit outstanding). Direct instruments operate by
setting or limiting either prices (interest rates) or quantities (amounts of
credit outstanding) through regulations, while indirect instruments act on the
market by, in the first instance, adjusting the underlying demand for, and
supply of bank reserves. Based on these descriptions, it can be noted that both
types of policy instruments play an important role in economic activities.
However, direct and indirect instruments do not have the same effectiveness in
improving market efficiency in the same economic environment. As has been
specified previously, the most common direct instruments are interest rate
controls, credit ceilings and directed lending. Alexander et al (1995: 15)
argued that «direct instruments are perceived to be reliable, at least
initially in controlling credit aggregates or both the distribution and the
cost of credit. They are relatively easy to implement and explain and their
direct fiscal costs are relatively low. They are attractive to governments that
want to channel credit to meet specific objectives». In countries with
very rudimentary and noncompetive financial systems, direct controls may be the
only option until the institutional framework for indirect instruments has been
developed. The same authors also showed the disadvantages of direct
instruments. These consist of the fact that credit ceilings are based on
amounts extended by particular institutions and therefore they tend to ossify
the distribution of credit and limit competition, including the entry of new
banks. All those advantages lead to the conclusion that direct instruments
often lose their effectiveness because economic agents find means to circumvent
Three main types of indirect instrument are mentioned:
-Open market operations
-Central Bank lending facilities
The open market operations are often seen as the most
important monetary policy tool because they are the primary determinants of
changes in interest rates and the monetary base and are the main source of
fluctuations in the money supply (Mishkin, 1997).
The way this instrument influences the economy can be seen
from purchase or sale of financial instruments by the Central Bank. Open market
purchases expand the monetary base, thereby raising the money supply and
lowering the short-term interest rates. Conversely, open market sales reduce
the reserves of the banking system, reducing the ability of banks to lend and
invest, and limiting the amount of funds available for the economy to use
(Federal Reserve System and Monetary Policy, 1979).
Open market operations are also based upon dynamic defensive
operations; dynamic operations are those taken to increase or decrease the
volume of reserves in order to ease or tighten credit. Defensive operations, on
the other hand, are those taken to offset the effects of other factors
influencing reserves and the monetary base.
Another interesting indirect monetary policy tool concerns the
changes in the reserve requirements. This consists of obliging banks to hold a
specified part of their portfolios in reserves at the Central Bank (Alexander
et al, 1995). This instrument affects the money supply by causing the money
multiplier to change.
Lastly, the Central Bank's lending facilities it is an
indirect instrument, which is often well known as discount policy. The discount
policy involves changes in the discount rate which affects the money supply by
affecting the volume of discount loans and the monetary base. A rise in
discount loans adds to the monetary base and expands the money supply whereas a
fall in discount loans reduces the monetary base and shrinks the money supply
Once all the instruments mentioned above are well applied, the
results easily seen in the level of economic activity since those instruments
influence the growth of the money supply as well as other financial
However, it is also worth noting that by using indirect
instruments, the Central Bank can determine the supply of reserve money in the
long term only under a fully flexible exchange rate regime. Even under a pegged
or managed exchange rate regime, however, Central Bank transactions affect
reserve money, at least in the short term. These transactions affect bank's
liquidity position, which results in adjustments to interbank, money market,
and bank loan and deposit interest rates to re-equilibrate the demand for, and
the supply of, reserve balances (Alexander et al, 1995).
2.3 MONETARY POLICY STRATEGIES
Having identified the instruments available for active
monetary policy implementation, it is important to understand the current
conduct of monetary policy. The latter needs to be operated within a
well-defined independent Central Bank.This means simply to provide the
authorities of Central Banks with the power to determine quantities and
interest rates on its own transactions without interference from government
institutions (Lybeck, 1998 quoted in Worrel, 2000). Similarly, Blinder (1998)
shows that Central Bank independence means two things: Firstly, that the
Central Bank has the freedom to decide how to pursue its goals, and secondly,
that its decisions are very difficult for other branches of government to
reverse. This implies that an independent Central Bank needs to be free of the
political pressures that influence other government institutions. This is
particularly important when a Central Bank needs to target inflation, exchange
rates or the monetary base for example. On this basis, an important point to
analyse could be the way Central Banks process before following a given
2.3.1 Choosing and Using a Target
As is already known, in conducting monetary policy, Central
Banks have the responsibility to achieve certain goals or final objectives. The
latter could be the inflation rate, the GDP and others. According to Mishkin
(1997) the strategy can be explained as follows: «after deciding on its
goals, the Central Bank chooses a set of variables to aim for called
intermediate targets such as monetary aggregates, interest rates etc. which
have a direct effect of the goals. The Central Bank's policy tools do not
directly affect these intermediate targets. Alongside this, the Central Bank
chooses another set of variables to aim for, called operating targets or
instruments among others reserve aggregates or interest rates which are more
responsive to its policy tools» (Mishkin, 1997: 478) In more general
terms, Mishkin argued that the main reason for trying to achieve its goal by
using intermediate and operating target, is simply to allow the Central Bank to
judge whether its policies are on the right path and to make mid-course
corrections, rather than waiting to see the final outcome of its policies.
The process starts from Central Bank policy tools and directly
affects the operating targets, which in their turn affect the intermediate
targets, and finally the latter affect the goals. As has been specified above,
the intermediate targets comprise monetary aggregates and interest rates. In
practice three criteria are suggested for choosing one target between them. The
three criteria can be summarised briefly as follows:
- Measurability: quick and accurate measurement of an
intermediate target variable is necessary because the intermediate will be
useful only if it signals when policy is off track more rapidly than the
- Controllability: The good intermediate target is the one on
which the Central Bank must be able to exercise an effective control.
- Predictable effect on goals: the goals must have a close
link with intermediate target chosen. (Mishkin, 1997:482).
The same criteria remain valid about choosing the operating
targets. A preferable operating target must have a more predictable impact on
the most desirable intermediate target.
The strategy described above is not, of course the only one
that allows a well conducted of monetary policy. In addition, Central Banks
have increasingly sought to reach their objective of macroeconomic stability
through the adoption of certain principles known as rules for monetary policy.
2.3.2 Monetary Policy Rules
According to Taylor (1998) the monetary policy rule is defined
as a description, expressed algebraically, numerically and graphically-of how
the instruments of policy such as the monetary base or federal funds rate,
change in response to economic variables. Taken in a general sense, a rule can
be defined as «nothing more than a systematic decision-making process that
uses information in a consistent and predictable way» (Taylor, 1998:2).
The concept of monetary policy rule is the application of this principle in the
implementation of monetary policy by the Central Bank (Poole, 1999). Svensson
(1998) defines a monetary policy rule simply as a prescribed guide for monetary
In policy conducted by rule, policymakers announce in advance
how the policy will respond in various situations, and commit themselves to
following through. Taylor (1998) notes that one monetary policy rule can be
said to be better than another monetary policy rule if it results in better
economic performance according to the same criteria such as inflation or the
variability of inflation and output.
In the following pages, various economic rules such as the
Exchange Rate Targeting Rule, the Money Supply Rule, GDP Targeting Rule,
Inflation Targeting Rule and Taylor Rule will be discussed in terms of their
abilities to guide Central Bankers.
126.96.36.199 Exchange Rates Rule
Exchange rate regime considerations play a strong role in
influencing monetary policy in a country. The rate of exchange means the price
of one currency in comparison with another currency. Mishkin (1997) argued that
«if a Central Bank does not want to see it currency fall in value, it may
pursue a more contractionary monetary policy and reduce the money supply to
raise the domestic interest rate, thereby strengthening its currency. Similarly
if a country experiences an appreciation in its currency, domestic industries
may suffer from increased foreign competition and may pressure the Central Bank
to pursue a higher rate of monetary growth in order to lower the exchange
rate» (Mishkin, 1997: 523).
The two most noted exchange rates regimes, fixed and floating
exchange rates tend to be extended from pegs to target zones, to floats with
heavy, light, or no intervention.
Initially, in a fixed exchange rate system, the exchange rates
are determined by the governments and Central Banks rather than the free
market, and are maintained through foreign exchange market intervention
(Dornbusch, Fisher and Startz, 2001). On the other hand, the same author
explains that the floating exchanges system is a system in which exchange rates
are allowed to fluctuate with the forces of supply and demand. The terms
flexible and floating rates are used interchangeably.
When it is taken into account that interventions can be made
from the flexible exchange rate depending on whether there is a need to get the
exchange rate floated with heavy or light intervention, as noted above, a third
way classification named the intermediate exchange rate system can be
mentioned. This rate is taken as floating rates, but within a predetermined
Accordingly, distinction is drawn between on the one hand,
dirty floating which is a flexible exchange rate system in which the Central
Bank intervenes in foreign exchange markets in order to affect the (short-term)
value of its currency and on the other hand, clean floating which is a flexible
exchange rate system in which the Central Bank does not intervene in foreign
exchange markets (Dornbusch, Fisher and Startz, 2001).
In the conduct of monetary policy based on exchange rate
target a major trading partner country needs to be selected and then a range of
values of the domestic currency to that country needs to be set. The major
partner retained should be characterised by a stable economy with low
inflation. The approach consists of maintaining the exchange rate at a target
range. This situation makes money supply endogenous because the Central Bank
needs to provide the foreign exchange or domestic currency demanded within the
set targets (Musinguzi and Opondo, 1999).
188.8.131.52 Money Supply Rule
Some economists, called monetarists believe that fluctuations
in the money supply are responsible for most large fluctuations in the economy.
They argue that slow and steady growth in the money supply would yield stable
output as well as stable rises in employment, and prices (Mankiw, 2000). This
view has been expressed in many works in terms of the quantity theory following
Fisher's equation of exchange.
From Fisher's equation:
Where M is the money supply, V is velocity, P the price level
and Y the real output level.
The term on the right (PY) is therefore nominal income or
Dynamizing the Fisher equation into growth rates:
(dM/dt)/M + (dV/dt)/V = (dP/dt)/P + (dY/dt)/Y
gM + gV = gP + gY
where gM = (dM/dt)/M, etc.
The equation of exchange holds by definition. The quantity
theory is reached by only adding certain assumptions about what is the cause
and what is the effect.
From the above equation thus, assumption are imposed:
- Nominal money M is assumed to be exogenous and considered
under the full control of the Central Bank,
- Velocity is assumed constant,
- The aggregate nominal demand component is assumed to cause
changes in nominal income (causality runs from MV to PY),
- Output Y is fixed at the full employment level.
If velocity is assumed to be constant, gV = 0, and
causality is held as in the third assumption, then movements in nominal output
(PY) are driven by movements in the supply of money (M). If real output is
assumed to be constant at the full employment level, and gY = 0,
gM = gP, meaning that money supply
growth feeds entirely into price inflation. As real variables (velocity and
output) are unchanged by an increase in the money supply, the quantity theory
thus claims that money is neutral (at least in the long-term).
When some assumptions are relaxed, especially by allowing for
output growth, gY ? 0 and changes in velocity, gV ? 0,
then these growth rates are relatively stable and predictable. In other words,
output is assumed to grow at a stable rate of resource growth while velocity is
assumed to increase at some relatively stable rate of institutional evolution.
gM - (gY - gV) =
gP so that inflation is driven by the degree to which money supply
growth exceeds the term (gY - gV) which means output
growth minus velocity growth. As the stability assumption implies that the term
(gY - gV) is constant, then, once again excess money
supply growth above this determines the inflation rate.
In practice, much of Friedman's assumptions were criticised.
For instance, the assumption of constant or stable velocity is considered as
not realistic. From empirical evidence, velocity may be subject to
unpredictable fluctuations caused by unpredictable changes in institutional
factors. Consequently, if velocity is not stable, the policy is not useful
since its effects will be unpredictable.
In addition, Mankiw (2000) argued that «although a
monetarist policy rule might have prevented many of the economic fluctuations
the world has experienced historically, most economists believe that it is not
the best possible policy rule. Steady growth in the money supply stabilizes
aggregate demand only if the velocity of money is stable. But sometimes the
economy experiences shocks, such as shifts in monetary demand that cause
velocity to become unstable» (Mankiw, 2000: 397). As a result, several
economists think that a policy rule should allow the monetary supply to adjust
to various shocks to the economy.
184.108.40.206 Nominal GDP Target Rule
The lost of reliability of monetary supply as a policy rule,
led economists to think that nominal GDP targeting might be a good fundamental
guide for policy. The idea argued that Central Bank should target nominal GDP
using one of several policy rules. Such a rule would specify how the Central
Bank should adjust to affect a short-tem interest rate in response to
deviations in nominal GDP from target (Clark, 1994).
One of the most important reasons why the monetary aggregates
rule is less reliable is nothing more than the fact that its relationship with
prices and output have deteriorated, apparently in response to financial
deregulation and innovation (Judd and Trehan, 1992 as quoted in Judd and
The way the nominal GDP targeting rule works can be explained
«Under this rule, the Central Bank announces a planned
path for nominal GDP. If nominal GDP rises above the target, the Central Bank
reduces money growth to limit aggregate demand. If it falls below the target,
the Central raises money growth to stimulate aggregate demand» (Mankiw,
Mathematically, Judd and Motley (1993) explained a simple way
to calculate the channel of influence from nominal GDP growth to inflation. The
following is the detail of their explanation:
(1) ?P = ?X - ?Y where ?P, ?X, and ?Y represent the annualized
growth rate of the implicit GDP deflation, nominal GDP, and real GDP,
respectively. The formula states that inflation is equal to the difference
between growth in nominal and real GDP. In the long-term, real GDP growth can
be approximated by a trend rate that is determined by real factors including
the growth in labour, capital, and productivity, and thus is largely
independent of nominal GDP growth. The result of this is that, any given growth
rate of nominal GDP can be translated into a corresponding inflation rate in a
simple way. The example mentioned is that trend (or potential) real GDP growth
is commonly estimated at around 2%, so that a 5% growth rate of nominal GDP
would fix long-term inflation at around 3%. Judd and Motley(1993) proposed in
the same sense that:
«Since the growth rate of nominal GDP is equal to the
growth rate of money (?m) plus the growth rate of velocity (?V), targeting
money can be seen as an indirect method of targeting nominal GDP» (Judd
and Motley, 1993: 4).
(2) ?X = ?m +?V
Putting these definitions together yields:
(3) ?P = ?m + ?V - ?Y
As long as trend velocity growth is stable, any given
long-term growth rate of money can be translated into a long-term inflation
rate in a straightforward manner. When the velocity of M2 was
stable, the relationship between M2 and inflation was particularly
simple, since historically, the trend growth rate of M2 velocity was
zero. Thus, for example, a 5% growth rate of M2 would produce a 5%
nominal GDP growth and a 3% rate of inflation in the long run. However, when
the velocity is unstable, direct nominal GDP targeting has the advantage that
it is not adversely affected by unpredictable swings in velocity. In effect,
nominal GDP targeting is a way to circumvent problems with the velocity of
money in conducting monetary policy.
220.127.116.11 Inflation Targeting Rule
Inflation targeting has been adopted as the framework for
monetary policy in a number of countries over the past decade. The existing
body of literature into this area shows that during the 1990's, New Zealand,
Canada, the UK, Sweden and Australia have shifted to that policy regime
(Svensson, 1998). In the general sense, under the inflation target rule, the
Central Bank would determine a target for the inflation rate (usually a low
one) and then adjust the money supply when the actual inflation deviates from
the target (Mankiw, 2000).
Several sources of literature in the area of monetary policy
show that the most important interest of any Central Bank is the desire for
price stability. One of the main reasons for that is simply that a key
principle for monetary policy is that price stability is a means to an end: it
promotes sustainable economic growth (Mishkin and Posen, 1997). In all of this,
Mishkin and Posen argued that a goal of price stability requires that monetary
policy be oriented beyond the horizon of its immediate impact on inflation and
Mathematically speaking, Svensson (1999) defines inflation
targeting as an equation where target variables are involved. More
specifically, in inflation targeting, the target variable is inflation in the
The equation can be expressed as follows:
Lt = ½ [(Ït -
Ï*) 2 + ëYt2]
Where Ït represents inflation in period t,
Ï* is the inflation targeting, Yt is the output gap
and ë is the relative weight on output-gap stabilization.
When ë = 0 this means that only inflation enters the
equation, the loss function is called strict inflation targeting whereas the
case when ë > 0 and the output gap enters the loss function is called
flexible inflation targeting. In most studies that have concentrated on
explaining the implementation of inflation targeting it has been shown that to
set the inflation target too low is risky because there is the possibility of
driving the economy into deflation with price levels falling unrealistically.
On the other hand, there is also the risk of allowing the start of an upward
spiral in inflation expectations and inflation.
Mankiw (2000) shows that in all countries that have adopted
inflation targeting, Central Banks are left with a fair amount of discretion.
Inflation targets are usually set as a range rather than a particular number.
The same author pursues the argument that the Central Bank is sometimes allowed
to adjust their targets for inflation, at least temporarily, if some exogenous
event (such as an easily identified supply shock) pushes inflation outside of
the range that was previously announced.
It is also important to note that there are certain
discussions which debate whether inflation targeting is a monetary policy rule
or not. Indeed, while Svensson regards inflation targeting as a monetary policy
rule, Bernanke and Mishkin (1997) and King (2003) show that inflation targeting
in practice is not a rule but it is a framework for monetary policy. This is
because, technically inflation targeting does not provide simple and mechanical
operating answers to the Central Bank.
According to the above authors, inflation-targeting allows the
Central Bank use all related information and structural economic model's to
decide their monetary policy and achieve their targets. Like this, the
inflation targeting should be taken as a framework for monetary policy.
The targeting of inflation has many important advantages in
principle as well as in practice. Mankiw (2000) explains that setting the
inflation target has a political advantage that is easy to explain to the
public. This is because when a Central Bank has announced an inflation target,
the public can more easily judge whether the Central Bank is meeting that
target. It therefore increases the transparency of monetary policy and, by
doing so, makes Central Bankers more accountable for their actions.
Considering the above advantages of inflation targeting, it is
well recognized that the success of inflation targeting cannot only be the duty
of the Central Bank: relevant fiscal policy and appropriated monitoring of the
financial sector are essential to its success.
However, apart from the success, inflation targeting also has
some disadvantages. Mishkin states these as follows:
«Because of the uncertain effects of monetary policy on
inflation, monetary authorities cannot easily control inflation» (Mishkin,
1997: 14). He supports this statement further by proposing that «it is far
harder for policymakers to hit an inflation target with precision than it is
for them to fix the exchange rate or achieve a monetary aggregate target»
(Mishkin, 1997: 14).
Another negative side of inflation targeting quoted is that
time delay of the effect of monetary policy on inflation are very long (the
estimates are in excess of about two years in industrialized countries). Thus,
in such case much time must pass before a country can evaluate the success of
monetary policy in achieving its inflation targets. Mishkin also proposes that
this problem does not arise with either a fixed exchange rate regime or a
monetary aggregate target.
More generally, evidence from different countries has shown
that inflation targeting can be used as a successful approach for gradual
disinflation. Consequently, the Central Banks of many countries now practice
inflation targeting, but allow themselves a little discretion.
18.104.22.168 The Taylor Rule
The Taylor rule is also known as a simple interest rate rule.
That is, simply speaking, it is the current practice where Central Bankers
could formulate policy in terms of interest rates. This rule was originally
proposed by the economist John Taylor following to the need of American Central
Bank to set the interest rates to achieve stable price while avoiding large
fluctuations in output and employment (Mankiw, 2000).
Considering the monetary transmission mechanism as the process
through which monetary policy decisions are transmitted into changes in real
GDP and inflation, Taylor (1995) argued that most Central Banks today are
taking actions in the monetary market to guide the short-term interest rate in
a particular way. In other words, rather than changing the money supply by a
given amount and then letting the short-term interest rate take a course
implied by money demand, the Central Banks adjust the supply of high-powered
money in order to give certain desired movements to the fund rate. The aim is
knowing how much the Central Bank should adjust the short-term interest rate in
response to various factors in the economy including real GDP and inflation.
Taylor proposed a simple interest rule in which the funds rate reacts to two
variables: the deviation of inflation from a target rate of inflation, and the
percentage deviation for real GDP from potential GDP.
Specifically, the Taylor rule can be written as follows:
Rt = r + Ðt + ë1
(Ðt - Ðt*) + ë2
(Yt - Yt*)
Based on the US context in which this rule was conceived, the
symbols in the equation are as follows:
Rt is the nominal federal funds rate, r is the
average equilibrium real federal funds rate, Ðt is the current
rate of inflation, (Ðt - Ðt*) is the
current rate of inflation less the inflation target,
(Yt - Yt*) is the output gap
specified as the excess of actual output over potential output. The
responsiveness of the nominal federal funds rate to the deviation of inflation
from target, and the output gap is determined by the weights ë1
and ë2. The way this rule works can be understood in simple
terms as follows:
The Taylor principle states that the Central Bank's policy
interest rate should be increased more than one for one with increases in the
inflation rate. The Taylor principle ensures that an increase in the inflation
rate produces a policy reaction that increases the real rate of interest. The
rise in the real interest reduces private spending, slows the economy down, and
brings inflation back to the Central Bank's inflation target. Conversely, if
inflation falls below the Central Bank's target, the Taylor principle calls for
a more than one for one cut in the Central Bank's policy interest rate. This
reduces the real rate of interest, stimulates private spending, and pushes
inflation back to its target level (Walsh, 2001).
Over several years there has been an emerging consensus among
economist authors that the Taylor rule appears to be a good description of the
interest rate policies of many Central Banks. Thus, Taylor's rule is the most
popular approach to the empirical analysis of reaction functions (Sanchez-Fung,
Mankiw (2000) shows that Taylor's rule for monetary policy is
not only simple and reasonable, but it also resembles the American Central Bank
behavior in recent years fairly accurately.
In the light of the different policy rules mentioned above, it
is worth noting that studies on monetary policy rules show that it is possible
to use very simple rules to achieve better economic performance. However,
generally speaking, the question of determining the best rule needs first of
all a better understanding of the transmission mechanism of monetary policy
through the economic system.
CHAPTER 3: MONETARY POLICY IN RWANDA
3.1 Macroeconomic Background
The destruction of the economic basis that took place during
the civil war period (1990-1994) and the genocide (1994) in Rwanda left an
economy in a shambles and characterized among others factors by:
- A very high rate of inflation (64% in 1994) that eroded real
incomes and damaged economic growth,
- A lack of financial control in government ministries leading
to large deficits,
- A narrow export base which concentrated on coffee and
- Dilapidated infrastructures due to the war and the looting
of saving banks. The institutional structure of the country was in latters.
Overall, the GDP had fallen between 1990 and 1994 by almost a
In response to these challenges, the government embarked along
an ambition path of economic reform which started at the end of 1994. Rwanda
made the transition from responding to emergencies to ensuring sustainable
development. The major objectives of the transition program have been focused
on laying the foundations of the transformation of the economy based on a
process of economic liberalization and turning away from control regulation and
state command to market policies. In the first phase, from 1995 to 1997,
macroeconomic policy reforms concentrated on reviving economic activity,
restoring macroeconomic stability and rebuilding the capacity for macroeconomic
and budget management.
The implementation of the economic reform programs benefited
from the help of IMF and World Bank. The key areas of reforms were in the trade
and exchange regimes, the fiscal area, the financial sector, and the
privatisation. The main emphasis of the policy package adopted was placed on
liberalizing the trade and payment regime. External tariffs were reduced,
exchange regulations were streamlined and further liberalized in 1998, and the
convertibility of the Rwanda francs for current account transactions were also
made in 1998. In the financial sector, in addition to liberalizing interest
rates, and the adoption of a Central Bank law that gave the National Bank of
Rwanda independence in monetary policy in 1997, a new commercial banking law
that provides for effective prudential regulation of commercial banks was
adopted in 1999.
The country began the process of recovery in earnest in 1995.
In 1995 growth in real GDP was 35.2%, in 1996, 12.7%; 1997, 13.8%; 1998, 9%;
1999, 7.6%; 2000, 6%; 2001, 6.8%; 2002, 9.9% (Republic of Rwanda, 2000)
However, it is important to emphasis that the international
community also played a significant role in that success. Indeed, Rwanda has
benefited from IMF and the World Bank sponsored Highly Indebted Poor Countries
(HIPC) debt relief initiatives to tune of US $ 850 million which is about US $
640 million in Net Present Value (NPV) terms. The principal government
objective is controlling inflation. This is being done through measures such
- Improvement in monitoring and control of budget
- Improvement in government saving by enhancing revenue
- Liberalization of interest rates. Monetary management has
shifted from direct controls to indirect monetary management through open
- Reform in tax policy, and the creation in 1997 of the Rwanda
Revenue Authority (RRA). The government took measures to improve the fiscal
situation mostly through improved tax and customs administration and tax
These measures were intended to address the traditional
sources of monetary instability in Rwanda, such as monetization of the fiscal
deficit and excessive borrowing from the commercial banks with a view to
strengthening the conduct of monetary policy and the process of financial
Many changes have been noticed in Rwanda from 1995. The
improvements reflect a commitment by the country to sound macroeconomics
policies and more open and better managed economies to address the many social
challenges that exist in the country. The success of such policies have often
been realised with the help of international community in the context of
Medium-Term Policy Programs supported by the IMF and World Bank. Between 1987
and 1999 this help was provided for African countries through the Fund's
Enhanced Structural Adjustment Facility (ESAF). But in late 1999, the ESAF was
transformed into the Poverty Reduction and Growth Facility (PGRF), signifying a
new approach to policy programs and poverty reduction. The issue, therefore, is
for Rwanda's Central Bank to design an appropriate framework that can
accommodate high economic performance in terms of GDP growth and price
stability while contributing to the poverty reduction in the country.
3.2 Monetary and Exchange Rate Policy Management
3.2.1 Monetary Policy
Since the Central Bank of Rwanda assumed its primary
responsibility of formulation and implementation of monetary policy following
the Central bank law that gave the National Bank of Rwanda independence in
monetary policy, several instruments of monetary policy have been actively
applied to regulate liquidity in the economy. The monetary programming has
helped to guide the National Bank of Rwanda's conduct of its monetary policy to
ensure that liquidity expansion is consistent with target inflation and GDP
Monetary programming as a tool of the Central Bank of Rwanda
is characterized especially by the way it describes the monetary by an indirect
character. The objectives that have been set to conduct monetary policy are the
- Final objective: control of inflation,
- Intermediate objective: monetary stock aggregate (M2)
because of the strong correlation between inflation and monetary stock,
- Operational objective: monetary base.
The frame of Central Bank's interventions in the indirect
character of monetary policy consists of:
- Projection of annual monetary balance,
- Forecast to be done on a monthly, quarterly and annual
- Weekly appreciation of the total level of the banking
liquidity by reference at the desired level of the monetary base.
The monetary instruments that have been used to conduct
monetary are among others:
- Monetary market, which was created in August 1997 as a
single framework for the allowance of the Central Bank currency and the
formation of interest rates through the levels of demand and supply. This
implies the interbank market interventions of Central Bank etc.
- Treasury bills market for monetary policy purposes or for
the needs of the government,
- Obligatory reserves as an instrument of banking liquidity
When the objectives and instruments to be used by the National
Bank of Rwanda are determined the next step to be specified in monetary
programming was focusing on the sources of the creation of currency or
counterparts of the money supply. The latter, as taken by the National Bank of
Rwanda, consists of Net External Assets (NEA) and Net Interior Assets (NIA)
(among others net credit to the private sector). Thus M2 can be expressed
M2 = NEA + NIA
According to the above relation, the change of M2 will consist
of the change of the counterparts (predominance of NEA or NIA). On the other
hand, the regulation of the monetary base follows the counterparts of the
monetary base, which are mainly Central Bank Net External Assets and Central
Bank Net Interior Assets.
The policy of stabilization and economic reforms after the war
period aimed at the re-establishment of fundamental balances. In 1997, as in
previous years, the Central Bank of Rwanda with the Ministry of Economy and
Finance defined an annual inflation target of 7% by the end of 1997. During
1998 and 2000 the inflation was set at below 5%. However, after the
modifications made to the economic program under PRGF (from 1999 to the
present) inflation has been set at 3%. In addition, the GDP growth rate has
been set at 12.7% in 1997; 7% in 1998 and at 6% in 1999 to 2003 in the context
The macroeconomic objectives undertaken during those years
were oriented towards restoring fundamental economic balances in order to allow
sustainable development. During that period, inflation came down from 11.7% in
1997 to -2.42% in 1999. Nevertheless, as shown in figure3-1, due to the great
inflationary uncertainty associated with the fact that the prices of food
products in Rwanda are often unstable due to the change of climatic conditions
(the drought in some areas) the annual targets for 1997 and 1998 were not
reached. However in 1999 and 2002 inflation was below the proposed target.
TABLE 3-1: INFLATION OBJECTIVE AND INFLATION OBSERVED IN
Inflation Objective (%)
Observed Inflation (%)
(Source: IMF and Rwanda, 1995-2002)
The monetary programme in Rwanda follows the change in
monetary stock (M2) as an indicator of inflation. The relationship between the
growth of the aggregate M2 and inflation in 1997-2003 periods can be shown in
the figure 3.1 below:
FIGURE 3-1: ANNUAL GROWTH OF AGGREGATE M2 AND INFLATION:
Table 3-2 shows the change in inflation and monetary stock. It
can be seen that the change in M2 depends on how is the predominance in the
change for NEA or NIA.
TABLE 3-2: MONETARY STOCK (M2), NET EXTERNAL ASSET (NEA) AND
NET INTERIOR ASSET (NIA) IN PERCENTAGE
Monetary stock (M2)
Net External Asset
Net Interior Asset
(Source: Banque Nationale du Rwanda, 2002)
3.2.2 Exchange Rate Policy
The main objectives of Rwanda's exchange rate policy are to
preserve the external value of the national currency and also to ensure the
effective operation of the foreign exchange market. The instruments that are
often used to conduct exchange rate policy are the rate of exchange and
exchange regulations. The latter comprises all the arrangements resulting from
the legislative texts and lawfully taken by the government in order to
supervise the management of foreign currencies.
The flexible exchange rate regime was established in Rwanda in
1995 and at the same time the organisation and the management of the foreign
exchange market were entrusted to the Central Bank.
The characteristic of the Rwanda flexible exchange rate regime
is the fact that it is a controlled flexible policy. The mentioned policy
pursues three main goals:
- To approach as much as possible the balance level of the
rate of exchange,
- The price stability and the support for the growth,
- To connect the Rwandan foreign exchange market to the
The instruments of the controlled flexible exchange regime in
Rwanda are simply the rate of exchange reference and the interventions of the
Central Bank on the foreign exchange market. The intervention of the Central
Bank on the foreign exchange market conforms to the pattern of its mission of
ensuring monetary stability and carrying out its objectives regarding the rate
of exchange. This is done with the aim of correcting imbalances of liquidities
of the market, as well as correcting the erratic movements of the national
In other respects, there is a close link between the monetary
policy and the exchange rate policy. Indeed, one of the principal counterparts
of the money supply, which is the Net External Assets constitute an important
source of monetary creation. According to this view, any positive balance of
the balance of payments results in an increase in the money supply, while any
deficit results in a reduction of the money supply. As a result, since the two
policies aim either at the preservation of the internal value of the currency,
or at its external value, their action must be harmonized for the stability of
With the help of international institutions such as the IMF
and the World Bank, the Central Bank of Rwanda is trying to follow an
objective, which entails developing a careful monetary policy, which will allow
it to maintain harmony between the pace of the money creation and that of
economic growth. The management of its stock change has contributed to reducing
the exerted pression on the Rwanda currency and foreign payments. The harmony
that has characterized the growth of the money supply and that of production
has contributed to stabilize the inflation rate, the currency exchange offer
has increased by 9% while it was 13.7% in 2000 (Republic of Rwanda, 2002:
CHAPTER 4 ILLUSTRATION OF THE MONETARY STRATEGY BY
MEANS OF A MODEL
Through economic research, various models have been developed
to better understand the monetary policy impact on the real economy and
ultimately inflation. `The management of monetary policy consists to define the
level of the instrument that, given the transmission mechanism of monetary
policy, is consistent with the achievement of the target' (Martinez, Sanchez
and Werner, 2000: 184). In the context of the conduct of monetary policy in
several countries, the achievement of inflation target has become the
fundamental goal of the monetary authority.
One way to evaluate the effectiveness of the monetary policy
is by estimating the effect on the interest rate of the variables that should
enter into the authorities reaction function. The Taylor rule mentioned
previously is one of the more popular approaches to the empirical analysis of
the reaction function. Indeed this rule works with the interest rate policy and
the latter implies the open market operations, which are often taken as the
most important monetary policy tool because they influence short-term interest
rates and the volume of money and credit in the economy.
The monetary reaction function based on the Taylor rule has
been used in both developed and underdeveloped countries. Judd and Rudebush
(1998) quoted in Hsing, (2004) investigated and reviewed previous works and
maintained that the Taylor rule is a valuable guide to characterize major
relationships among variables in conducting monetary policy. Similarly, Romer
(2001) quoted again in Hsing, (2004) analysed several issues in applying the
Taylor rule. He noted that the values for the coefficients of the output gap
and the inflation gap would change the effectiveness of monetary policy. Larger
values of the coefficients would cause the actual inflation rate and output to
decline more than expected. Due to a lag in information, it would be more
appropriate to use the lagged values for the output gap and the inflation gap.
The exchange rate and the lagged federal funds rate need to be included to
incorporate the open economy and the partial adjustment process. Martinez,
Sanchez and Werner (2000) analysed the mechanisms empirically by which the
transmission of monetary policy has occurred in the Mexican economy from 1997
to 2000. Using VARS he found that the behavior of the real interest rate was
determined by the traditional variables that guide the discretionary actions of
any Central Bank and that this rate affected aggregate demand and credit in a
statistically significant way. Applying the VAR model, Hsing (2004) estimated
the monetary policy reaction function for the Bank of Canada. The results show
that the overnight rate has a positive and significant response to a shock in
the output gap, the inflation gap, the exchange rate or the lagged overnight
rate. The author pursues the latter concluding that the main outcomes suggest
that in pursuing monetary policy by the Bank of Canada, targeting output is as
important as targeting inflation.
Sanchez-Fung (2000) estimated a simple Taylor-type monetary
reaction function for Dominican Republic during the period 1970-98. He noted
that the implicit reaction of such authorities suggest that they were more
systematic during the period 1985-98 which might be attributed to a
determination to» implicitly» follow feedback rules, rather than
discretion, in monetary policy-making. Setlhare (2003) studying how monetary
policy was conducted in Botswana by specifying and estimating an empirical
monetary policy reaction for the Bank of Botswana over the period 1977-2000,
identified a predominantly countercyclical policy reaction function. This
reaction function suggests that inflation (directly and indirectly via the real
exchange rate) is the ultimate variable of policy interest.
Smal and Jagger (2001) examined the monetary transmission
mechanism in South Africa. The results of the model developed indicated that
there was a fairly long time (one year) before a change in monetary policy
affected the level of real economic activity, and another year before it had an
effect on the domestic price level.
Sanchez-Fung (2000) however, observed that although the
framework related to Taylor type monetary policy reaction has been implemented
in the analysis of advanced economies, little work has been done for less
The purpose of the following section will look at how monetary
policy was conducted in Rwanda by specifying and estimating a monetary reaction
function for National Bank of Rwanda.
4.1 EMPIRICAL ANALYSIS
4.1.1 Reaction function for Rwanda
Rwanda is a small open economy and it is necessary to examine
how monetary policy reacts to output gap, inflation gap and exchange rate.
To formulate a monetary reaction function for National Bank of
Rwanda the Taylor rule equation was adapted to the context of monetary policy
in Rwanda. Indeed, Osterholm (2003) showed that the Taylor rule could be
estimated where the rule has been used by Central Banks or at least be a close
enough approximation to Central Bank behavior.
The original Taylor rule can be expressed as following:
FFR=f (YG, IG) (1)
FFR= the federal funds rate,
YG= the output gap,
IG= the inflation gap which is (-*), where is the
actual inflation rate and * the target inflation rate.
The present study will follow suit by specifying and
estimating a version of (1). That is, will be determined a variable that seems
to be a plausible indicator of the stance of monetary policy in Rwanda.
Evidence suggests that the short-term interest rate cannot be applied to the
realities of developing countries when taken as an instrument in conducting
monetary policy given the underdeveloped nature of the financial market. It has
been argued that the monetary base is the most appropriate instrument to be
used in developing countries (Sanchez-Fung, 2000).
Because of data availability problems for the monetary base
series of Rwanda, the monetary stock aggregate (M1) will be used as the
instrument policy. Indeed, the monetary stock aggregate (M1) plays an important
role in Rwanda monetary policy since the National Bank of Rwanda assumed its
responsibility to regulate liquidity in the economy and the data of the
monetary base are frequently referred to M1.
In respect of goal variables, inflation and output will be
used. The former variable has emerged from many economists as the real goal of
monetary policy in order to maintain price stability and the latter is
considered as a historically objective of monetary policy in various
In the context of Rwanda, the strategy used by the Central
Bank is to ensure that liquidity expansion is consistent with target inflation
and GDP growth levels. Thus, the modified version of Taylor's rule to be
estimated can be written as:
Mt= ë0 + ë1 (IGt) +
ë2 (YGt) + t (2)
However, recently, with number of empirical studies related to
the Taylor rule, economists argue that the exchange rate would also be an
essential state variable that has to be included in the model in the case of a
small and open economy (Osterholm, 2003). On this basis, the equation (2) is
extended as follow:
Mt= ë0 + ë1 (IGt) +
ë2 (YGt) + ë3DEXt +
Where Mt = monetary stock aggregate (M1),
DEXt = the change in exchange rate in
terms of the Rwandan Francs per US
t = the error term and
ë2, ë3 are constant term and coefficients
respectively to be estimated empirically.
The equation (3) can be seen as a function in which the
monetary stock aggregate (M1) reacts to the inflation gap, output gap and the
change in exchange rate.
The version of the equation (3) to be empirically estimated
can take a dynamic form since there is the lag response of Monetary Authority.
On this basis, the equation (3) is expressed as follows:
Mt= 0 + 1Mt-1 +
2IGt + 3IGt-1 +
4YGt + 5YGt-1 +
6DEXt + 7DEXt-1 + t
Equation (4) is an autoregressive-distributed lag of order one
[ADL (1, 1)]. This formulation allows one to consider that the forecast value
of M at time t is simply the reaction of monetary authorities to
past and current economic states. Moreover, following Sanchez-Fung (2000: 9)
one should consider that, statistically; equation (4) could help to justify the
problem of wrongly measured data.
The econometric analysis of the version of Taylor rule
retained for Rwanda will be undertaken using quarterly data during 1997 (Q1) -
2001(Q4), simply because the monetary authorities actually began to carry out
monetary policy in an independent way from 1997. However, data for the
variables after 2001(Q4) are not available.
Real GDP, Index of Consumer Prices, monetary stock aggregate
and nominal exchange were obtained from the Central Bank of Rwanda and have
been all transformed in logarithm form, except the Index of Consumer Price. In
addition, the inflation rate is calculated as the change over four quarters of
the seasonally adjusted harmonised Index of Consumer Prices and the inflation
gap has been taken as the difference between the observed inflation and the
inflation target. The Inflation target is not constant and was obtained from
IMF and Rwanda (1995-2002) and the National Bank of Rwanda. Potential output is
estimated based on the Hodrick-Prescott Filtering Process and the output gap is
expressed as (Y-Y*), where Y is the output and Y* is the
potential output. The monetary stock aggregate variable has been de-trended
using the HP filter (see Pesaran and Pesaran, 1997). The nominal exchange rate
reported is in terms of Rwandan Francs per US Dollar because of the extensive
use of US Dollars to dominate international transactions (Republic of Rwanda,
By using this data, the focus will be on estimating the model
(4) using Microfit 4.0 and by checking whether the estimated parameters of the
regression are meaningful to interpretation.
22.214.171.124 Time series properties of the data
Prior to carrying out the model, it is necessary to examine
the time series properties of the variables included in it. This allows one to
determine whether or not the regression is spurious. For this purpose
stationarity of the data set is checked by using a simple appropriate test
named Dickey- Fuller. The lag length used in the test is determined using the
AKAIKE (AIC) and the Schwartz Bayesian Criterion (SBC) mainly. According to
this criterion, the model to be preferred should have the highest AKAIK or the
Tables (4.1) and (4.2) present the integration test results
for variables in their level form and in first difference respectively.
TABLE (4.1): UNIT ROOT TEST-LEVELS OF VARIABLES
Monetary stock aggregate (M)
Inflation gap (IG)
Output gap (YG)
Exchange rate (EX)
Note: ADF critical values:
* Significant at the 1% level
** Significant at the 5% level
TABLE (4.2): UNIT ROOT TESTS OF THE FIRST DIFFERENCE
Note: ADF critical values:
* Significant at the 1% level
** Significant at the 5% level
The results reported in Table (4.1) indicate that all the
variables are stationary in levels except for the nominal exchange rate. The
unit root for the variables, which are stationary, is rejected at all the
conventional significance levels (the null hypothesis states that the time
series has unit root and the alternative is that the time series does not have
From table (4.2) when the variables are transformed to their
first differences, the ADF test rejects the null hypothesis about unit root at
the all-conventional level of significance for all the variables except the
inflation gap which rejects the unit root at the 5% level of significance.
Therefore, all the variables are first - difference stationary. Overall, it can
be concluded that all the variables in the model (equation 4), including the
exchange, rate can be treated as I (0) because the exchange rate expressed in
the model relates the change in the nominal exchange rate. Consequently, the
Ordinary Least Squared (OLS) analysis by the feedback rule in which the
monetary stock aggregate reacts to the inflation gap, the output gap and the
exchange rate or all of them will provide non - spurious results.
Having the monetary stock aggregate (M1) as the dependent
variable, one expects that the monetary stock aggregate will increase if
inflation is below target, output is below the output gap, that is, the
coefficient of YG and IG are expected to carry a negative sign. Regarding the
change in the nominal exchange rate, we expect that the response of M to DEX
would be negative.
4.2 Estimation results
The results from OLS estimation of our model are displayed in
Table 4.3: ORDINARY LEAST SQUARES ESTIMATION
Dependent variable is HD
20 observations used for estimation from 1997Q1 to 2001Q4
Regressor Coefficient Standard Error
C .041926 .018295
HD(-1) -.55205 .24191
IG .87528 .34904
IG(-1) -.76760 .29924
YD .57167 .57095
YD(-1) -.14445 .52748
DEX .032610 .65972
DEX(-1) -1.9057 .76955
R-Squared .72147 R-Bar-Squared
S.E. of Regression .040975 F-stat. F( 7, 12)
Mean of Dependent Variable .0099828 S.D. of Dependent
Residual Sum of Squares .020147 Equation
Akaike Info. Criterion 32.6254 Schwarz Bayesian
DW-statistic 2.1915 Durbin's h-statistic
* Test Statistics * LM Version * F
* * *
* A:Serial Correlation*CHSQ( 4)= 8.6706[.070]*F( 4,
* * *
* B:Functional Form *CHSQ( 1)= .74496[.388]*F( 1,
* * *
* C:Normality *CHSQ( 2)= 1.2503[.535]* Not
* * *
* D:Heteroscedasticity*CHSQ( 1)= 5.7353[.017]*F( 1,
A:Lagrange multiplier test of residual serial
B:Ramsey's RESET test using the square of the fitted
C:Based on a test of skewness and kurtosis of residuals
D:Based on the regression of squared residuals on squared
Source: Microfit outputs
Considering the full sample period 1997-2001, the coefficient
of YGt, YGt-1 and DEXt are insignificant and
carry unexpected signs and the model fails the serial correlation and
heteroscedasticity test. When reducing the model by taking out all the
insignificant variables the final preferred model is specified as following:
Mt= 0 + 1Mt-1 +
2IGt + 3IGt-1+
4DEXt-1 + t (5)
This complies with most of the diagnostic statistics regarding
no serial correlation, good functional form, normality and the absence of
heteroscedasticity. On the other hand, the R2 and the adjusted
R2 are fairly good and the signs of the estimated coefficient in the
relation to their prior expectation are satisfactory.
The results are shown in Table (4.4) as the following:
Table 4.4: ORDINARY LEAST SQUARES ESTIMATION
Dependent variable is HD
20 observations used for estimation from 1997Q1 to 2001Q4
Regressor Coefficient Standard Error
C .058537 .014898
HD(-1) -.46291 .22639
IG .96117 .30511
IG(-1) -.64710 .26722
DEX(-1) -2.4506 .55757
R-Squared .64415 R-Bar-Squared
S.E. of Regression .041425 F-stat. F( 4, 15)
Mean of Dependent Variable .0099828 S.D. of Dependent
Residual Sum of Squares .025740 Equation
Akaike Info. Criterion 33.1755 Schwarz Bayesian
DW-statistic 2.3383 Durbin's h-statistic
* Test Statistics * LM Version * F
* * *
* A:Serial Correlation*CHSQ( 4)= 3.9091[.418]*F( 4,
* * *
* B:Functional Form *CHSQ( 1)= 1.9189[.166]*F( 1,
* * *
* C:Normality *CHSQ( 2)= 2.0604[.357]* Not
* * *
* D:Heteroscedasticity*CHSQ( 1)= 1.4580[.227]*F( 1,
A: Lagrange multiplier test of residual serial
B: Ramsey's RESET test using the square of the fitted
C:Based on a test of skewness and kurtosis of residuals
D:Based on the regression of squared residuals on squared
(Source: Microfit output)
The regression is significant as demonstrated by the
F-statistic, which provides a test that the true value of the slope
coefficients are simultaneously equal to zero (the p-value 0.003 is almost
The goodness of fit, as measured by the coefficient of
determination R2, indicates how well the sample regression line fits
the data. The fit indicates that about 64.4% of changes in monetary stock
aggregate are explained by monetary stock aggregate in the one period lagged,
the current inflation gap, the one period lagged inflation gap and the one
period lagged change in the nominal exchange rate. When examining each
explanatory variable it was found that:
- The response coefficients on inflation gap are about 0.96
and -0.65 respectively the contemporaneous and the one period lagged value.
- Both coefficients are statistically significant at the 5%
level of significance.
- The response on the change in the one period lagged value of
nominal exchange rate is(-2.45).
- Judging by the t-ratio, the coefficient is significantly
different from zero at the all-conventional level of significance.
- The response coefficient on the one period lagged value of
the monetary stock aggregate is about (-0.46) and judging by the t-ratio, the
coefficient is significantly different from zero at the 10% level of
According to those estimation results, the interpretation is
(1) Considering the one period lagged value of the monetary
stock aggregate (Mt-1), one can observe that a one percentage point
change in the previous period monetary stock aggregate results in about 0.46%
point change in the current monetary stock aggregate in the opposite sense,
holding other things the same. This means that, there is one to 0.46 inverse
relationship between the previous and the current monetary stock aggregate.
(2) Considering the current and the one period lagged
It is noticed that for a given change in the one period lagged
deviation of the inflation from its target, the monetary stock aggregate reacts
by a change of about 0.65 units. This impact seems statistically significant
since the t-ratio is significant and the coefficient carries the right expected
sign. This means that, if inflation were 1% point above its target, the Central
Bank would decrease the monetary stock aggregate by 0.65% in terms of reaction,
holding other things the same. Thus, the Central Bank was reacting to one
period lag on the deviation of inflation from its target by a weight of about
0.65. Regarding the current period of inflation gap, the coefficient 0.96 can
be interpreted as the change in the value of monetary stock aggregate following
a unit change in inflation gap in the same period. That is, the monetary stock
aggregate was changing in the same sense as the price level by 0.96% following
a 1% change in prices.
(3) Considering the exchange rate:
The result shows that the Central Bank of Rwanda
reacts to 1% change in the exchange rate by a change of 2.45% in the monetary
stock aggregate inversely, holding other things the same.
In the light of the above findings, the Rwanda Central Bank's
behavior in respect to the weight carried by the inflation gap in the current
period and the one period lagged should be interpreted cautiously. Indeed, from
the estimated of equation (4), the coefficient affecting the variable
IGt is positive and significant whereas the one affecting the
variable IGt-1 is negative and significant as well. This seems to
show that the Central Bank reacts mainly to the inflation focusing on the one
period lagged of the state of the economy while the positive contemporaneous
relationship between the monetary stock and the inflation gap could be seen as
the period of economic state adjustments. That is, dynamically speaking, in the
current period the change in price leads the monetary policy to adjust the
monetary base toward its trend. Overall, the change in the one period lagged in
the exchange rate seems to be more influential than the inflation rate in
explaining the change in monetary policy since the coefficient of the former
carries the expected sign and its t-ratio is relatively very significant.
When looking at the result more closely with the objective of
highlighting the variable that has influenced monetary policy decisions over
the period of study, it is apparent that the monetary authorities were mainly
concerned with the exchange rate. This is relevant given the importance of the
exchange rate in a small, open, and developing country especially Rwanda, in
the present case. Indeed, as noted previously, the exchange rate policy in
Rwanda aims at approaching a balanced level of the exchange rate, to stabilise
prices, to ensure a support for the growth and to connect Rwanda's foreign
exchange market to the international market. These objectives are pursued under
a controlled flexible policy regime, that is, the exchange rate can fluctuate
from day to day but the Central Bank attempts to influence the exchange rate by
buying and selling currencies in the foreign exchange market. The impact of
such interventions is to affect the monetary base. According to this fact, the
exchange rate considerations play a great role in the conduct of monetary
policy and this has been shown through the estimation results. The exchange
rate coefficient from the results leads one to consider that a depreciation of
Rwanda Francs may lead the Central Bank to pursue a kind of contractionary
monetary policy and similarly, an appreciation in Rwanda Francs may lead to
pursue a high rate of money growth and such reaction consists basically in
acquiring or selling of international reserve.
Given the fact that Rwanda has a strong dependence on
assistance from multilateral financial institutions which in its turn has a
real impact on the balance of payment, apparently, the importance of reacting
to exchange rates seems to be relevant in Rwanda since it could limit the
pressure exerted on the Rwanda currency in order to meet international prices
and the debt service management. In addition, these findings about the exchange
rate influence on monetary policy are consistent with the state of the Rwanda's
economy from 1995 when it started to benefit from financial assistance from
international institutions in the context of the Enhanced Structural Adjustment
Facility (ESAF) and the Poverty Reduction and Growth Facility (PRGF). This may
lead one to think that changes in the flow of international assistance could
contribute to the significant changes in official reserves for the country. As
a consequence, an objective of Rwanda currency stability should play an
important role given the link between the foreign market operation and the
change in monetary base and thereby the behavior of prices level. In this
specific context, one could consider that monetary authorities were not as
concerned about reacting to changes in the inflation as to the exchange rate
simply because when focusing on the exchange rate, the Central Bank has also
attempted to stabilize prices given the fact that the depreciation of Rwandan
Francs and the increase in international prices affects the inflation rate.
Comparing these findings with the suggestion of the Taylor
rule, it would appear that the weight of the inflation gap does not correspond
to the Taylor rule's description which sets the weight greater than one. In
addition, the estimates indicated a neglect of output gap as a goal variable
under the period of study (see Table 4.3). These results may indicate that the
Taylor rule adapted to the context of monetary policy in Rwanda expresses that
the economy behaved by giving much importance to the exchange rate than to
inflation and neglected the output change.
CHAPTER 5 CONCLUSION AND SUGGESTION
This dissertation intended to study how monetary policy was
conducted in Rwanda. The task has been accomplished by designing and estimating
a Taylor rule, monetary policy reaction function for the National Bank of
Rwanda over the period 1997-2001.
Applying Ordinary Least Squared (OLS) on data taken from the
National Bank of Rwanda, the Ministry of Economic and Finance of Rwanda and the
IMF together, the study shows that the National Bank of Rwanda has had a
monetary policy over the years with the monetary stock aggregates (M1) as the
The Rwanda Central Bank's reaction function can be
- A contemporaneous inflation gap weight of (0.96), which is
positively related to the monetary stock aggregate,
- A previous quarter inflation gap weight of (-0.65), which is
negatively related to the monetary stock aggregate,
- A previous quarter change in exchange rate weight of
(-2.45), which is negatively related to the monetary stock and
- A previous quarter monetary stock aggregate weight of
(-0.46), which is also negatively related to the current monetary stock
Judging these results according to the importance of each
variable weight, one may be inclined to contend that while the National Bank of
Rwanda reacted to the inflation from the previous quarter and the
contemporaneous period, there was a much stronger response to the change in the
previous quarter's exchange rate.
In general, such strong response of the National Bank of
Rwanda to the exchange rate may reflect the economic environment in which the
monetary policy was operating, because international aid has flow into Rwanda
since 1995 in the context of various economic programs undertaken with the help
of the International Monetary Found (IMF) or World Bank (WB). In addition, the
estimate results indicated a neglect of output gap as a goal variable.
Given the fact that the Rwanda Central Bank claimed to be
following the objective of preserving the internal and the external value of
the currency in order to maintain harmony between the pace of the money
creation and that of economic growth it may be suggested that the Central Bank
of Rwanda should give more consideration to the way the output changes, that
is, the Central Bank should respond to the variation of output gap following
the influence of its change in the economic state.
In addition, the results of this study of course, are backward
looking, in the sense that they represent the relationships that existed so far
in the data. It is worth noting that a forward-looking model may enable the
implantation of a more successful monetary policy rule for Rwanda and there may
be areas for future research.
Backhouse, R. (1999). Applied UK macroeconomics.
Massachusetts: Basil Blackwell
Blinder, A. S. (1999). Central Banking in theory and
practice. Massachusetts: The MIT Press
Daniels, J. , Vanhoose, D. (1999). International monetary
and financial economics. Cincinnati: South-Western College Publishing
Darnell, A. C. (1994). A dictionary of econometrics.
Brookfield: Edward Edgar Publishing limited.
Dornbusch, R. , Fisher, S. , Startz, R. (2001).
Macroeconomics. 8th Edition. New-York: McGraw-Hill
Edwards, G. T. (1984). How economic growth and inflation
happen. London: Macmillan Press
Enders, W. (1995). Applied econometrics time series.
New-York: John Wiley and Sons.
Frowen, S. F. (1993). Monetary theory and monetary
policy. London: The Macmillan press.
Gujarati, D. (1992). Essentials of econometrics.
Mankiw, N. G. (2000). Macroeconomics. 4th
Edition. New-York: Worth Publisher
Meyer, L. H. (1980). Macroeconometrics, a model bulding
approach. Cincinnati: South Weatern Publishing Co.
Mishkin, F. S. (1997). The economics of money, banking and
financial. 5th Edition. Massachusetts: Addison-Wesley
Pesaran, M. H., Pesaran, B. (1997). Microfit 4.0.
Oxford: Oxford University Press.
Wallich, H. C. (1982). Monetary policy and practice.
Lexington: D. C. Heath
Walsh, C. E. (1998). Monetary theory and policy.
Massachusetts: The MIT Press.
Journals, Working Papers
Alexander, W. E., Thomas, J. T. , Balino, Enoch, C. (1995).
An Adopting Indirect Instrument of Monetary Policy. IMF
Occasional Paper No 126. Washington.
Clark, T., E. (1994). Nominal GDP Targeting Rules: can they
stabilize economy? Federal Reserve Bank of Kansas City. Economic Review,
Third Quarter 1994
Federal Reserve System and Monetary policy (1979).
Congressional digest, Vol 58 issue 4: p101 2p (AN 10584253)
Gidlow, R. M. (1998). Instrument of monetary policy in
South Africa. south Africa Reserve Bank, January 1998.
Government of Rwanda (2001). Third United Nations
Conference on the Least Developed Countries. Brussels, 14-20 May
2001. Action Prgramme for the Development of Rwanda 2001-2010.
Hsing, Y. (2004). Estimating the monetary policy reaction
function for Canada. A VAR model. Southeastern Louisiane University.
Vol.3 No.1 Appril (2004)
Judd, J. P., Motley, B. (1993). Economic Review Federal
Reserve Bank of SanFrancisco. 1993. Pages: 3-11.
Judd, J. P. , Rudebusch, D. (1998). Taylor Rule and the
Fed: 1970-1997. FRBSF Economic Review 1998, No3
Martinez, L. , Sanchez, A. , Werner, A. (2000). Monetary
policy and the transmission mechanism in Mexico. BIS paper No8.
Paper presented at the seminar on stabilization and monetary policy organized
by the Bank of Mexico, November 2000.
Mishkin, F. S., Posen, A. S., McDonough, W. (1997) Special
Issue on Inflation Targeting. Economic Policy Review. Vol3, No3.
Federal Reserve Bank of New-York, 1997.
Mishkin, F. S. (1995). Symposia on the monetary
transmission mechanism. The journal of Economic Perspective. Vol.9 No 4
Musinguzi, P. , Opondo, H. (1999). Bank of Uganda Staff
Paper. Vol 1. No 1. 1999.
Musinguzi, P. , Obwona, M. B., Stryker, D. J. (2000).
Monetary and exchange rate policy in Uganda. African Economic
Policy Discussion Paper No23, April 2000.
Republic of Rwanda (2000). Rwanda Development
Indicator. Ministry of Finance, Kigali.
Republic of Rwanda (2002). Rwanda Development
Indicator. Ministry of Finace, Kigali
Sanchez-Fung, J. R. (2002). Estimating a monetary policy
reaction function for the Dominican Republic. Discussion Paper No
02/01 Department of Economics. University of Kent, UK.
Small, M. M. ,de Jager S. The monetary transmission
mechanism in South Africa. Occasional Paper No.16, September 2001, South
African Reserve Bank.
Stryker, J. D. , Rajaratnam, B. , Cassim, F. (2000) The
effect of fiscal, monetary, and exchange rate policy on the South
African growth and employment. TIPS 2000 Annual Forum September 2000.
Svensson, L. E. O. Inflation Targeting as a Monetary Policy
Rule. Journal of Monetary Economics 43 (june 1999), pp. 607-54.
Taylor, J. B. The monetary transmission mechanism:
an empirical framework. The Journal of Economic Perspectives, Vol 9 No 4
Worrel, D. (2000). IMF Working Paper. Money and Fiscal
Coordination in Small Open Economies. WP/00/56. International
Aron, J. , Muellbaner, J. (2001). Estimating monetary policy
rules for South Africa. Oxford. (
Accessed March 2004
Banque Nationale du Rwanda. (2002). Politique Monetaire par la
BNR: Rôle et perspectives. (
Accessed May 2004
Bernank, B. Mishkin, F. S , Milhov. What does the Bundesbank
target? Europen Economic Review, 4 (june 1997). (
Accessed july 2004
Christensen, A. M. , Nielsen, H. B. (2003). Has US monetary
policy followed the Taylor Rule? A cointegration analysis. 1988-2002. JEL
classification: C32, E52.
Accessed May 2004
Economic New School (
Accessed May 2004
Esanov, A. , Merkl, C. , de Souza, V. (2004). A preliminary
evaluation of monetary policy rules for Russia. Duestembrooker Weg 120 24 105
Kiel. Kiel Working Paper No.1201. (
Accessed July 2004
Federal Reserve Bank of SanFrancisco (2004). US monetary
policy: an introduction.
Accessed March 2004
Hsing Y. (2003). Estimating the Bank of Japan's monetary
policy reaction function. Working Paper.
Accessed June 2004
IMF (2000). Policy for faster growth and poverty reduction in
Sub-Sahara African and the role of the IMF. An IMF Issues Brief. (
www.imf.org) Accessed March 2004
IMF (2001) IMF concludes article IV consultation with Rwanda.
Public information notice (PIN) No.01/31 March 27, 2001. (
www.imf.org) Accessed March 2004
IMF and Rwanda (1998-2001). Rwanda-enhanced structure
adjustment facility economic and financial policy framework paper for
www.imf.org) accessed March 2004
IMF and Rwanda (1997-2001): Press release index for
www.imf.org) Accessed March
King, M. (2003). What has inflation targeting achieved?
Accessed March 2004
Osterholm, P. (2003). The Taylor rule: a spurious regression?
JEL classification: E52.
Accessed May 2004
Poole, W. (1999). Monetary Policy Rules? The Federal Reserve
Bank of St Louis Review, Issues 1999 March/April, 1999 vol.81, No2. (
Accessed April 2004
Sanchez-Fung, J. R (2000). Estimating a Taylor-type monetary
policy reaction function for a small developing economy. JEL classification: E5
Accessed April 2004
Setlhare, L. A. (2003) close look at Botswana's management of
monetary policy: the reaction function approach.
Accessed June 2004
Svensson, L. E. O. (1998). Inflation targeting as monetary
policy rule. Working paper 6790 JEL No E42, E52.
Accessed April 2004
Taylor, J. B. (1999). The monetary transmission mechanism and
the evaluation of monetary policy rules. Third annual international conference
of Central Bank of Chile on monetary policy rules and transmission mechanism.
September 20-21, 1999 WP No.87
Accessed May 2004
Taylor, J. B. (1998). An historical analysis of monetary
policy rules. Working Paper 6768. Cambridge: National Bureau of Economic
Accessed April 2004
Walsh, C. E. (2001). The science(and art) of monetary policy.
Federal Reserve Bank of Sanfrancisco. Economic Letter 2001-13, May 4, 2001.
Accessed April 2004
Worrel, D. (2000). Monetary and fiscal coordination in small
open economies. IMF working paper. WPI/00/56 JEL classification No.E63, E58
Accessed March 2004
APPENDIX1: PRELIMINARY DATA (1995Q1-2001Q4)
Consumption Price Index
Monetary stock aggregateM1
In 109 of Rwandan Francs
M1 in 106 of Rwandan francs
Source National Bank of Rwanda, Ministry of Finance and IMF