The primary objective of the National Bank of Rwanda’s monetary policy is to ensure price stability, contributing to sustained macroeconomic stability. In the last two decades ending December 2018, the NBR conducted its monetary policy by targeting the quantity of money to achieve that objective. Under that monetary targeting framework, NBR managed to keep inflation low and stable, by providing the quantity of money in the economy - broad money aggregate - in line with inflation and economic growth objectives.
In January 2019, the National Bank of Rwanda shifted from the quantity-based monetary policy framework, to a price based approach, after five years of preparations.
Why was it necessary to change the monetary policy framework?
While the price and macroeconomic stability achieved under the monetary targeting regime were commendable, the ongoing economic transformation in both real and financial sectors were starting to pose new challenges that could weaken the link between inflation and broad monetary aggregates. In addition, the Bank observed a tendency among economic actors to increasingly focus on interest rates in their consumption and saving decisions, as a result of the recent developments in the domestic financial system (including the avenue of new financial products and modern payment systems). These trends are reflected in the surge in term deposits as well as investments in government securities by retail and institutional investors. Under those circumstances, a more forward-looking monetary policy that use interest rate as operating target to guide market expectations became the most relevant framework.
In addition to the forward-looking aspect, the price-based monetary policy offers several advantages over the quantity-based monetary policy. First, a price-based monetary policy has the advantage that a stable relationship between money and inflation is not critical to the success of monetary policy. Second, prices of money (interest rate) and goods and services (as measured by inflation) can be easily understood by the general public and market players, which enables more effective communication, greater transparency and increased accountability of NBR.
How was the transition towards the new monetary policy framework?
Adopting the price-based monetary policy framework, requires a strong analytical capacity to support forward-looking decision-making, a developed financial market, enhanced communication and modernized monetary policy processes, among other things.
The NBR built econometric models and initiated expectations surveys.
In the transition period, the NBR significantly invested in capacity development of its staff. The bank developed in-house forecasting models in collaboration with different partners, including international organization and other central banks. To support the forecasting models, NBR introduced Price Expectations Surveys (PES) to enhance evidence based analysis. PESs are conducted on quarterly basis, in line with the MPC calendar of meetings.
The NBR was keen to clear and timely communication.
NBR has put in place a communication strategy, which is key in a price-based monetary policy framework. To anchor price expectations, NBR regularly communicates to the public its policies and decisions, the rationale behind the decisions, the anticipated impacts of the decisions and key macroeconomic trends through press conferences, press releases and different publications. The target groups include the public, financial sector players, think tanks, media, youths, academia, policy makers and international organizations.
The Bank devoted to develop money markets.
With the perspective of boosting interbank market activities and therefore enhance monetary policy transmission mechanism, the NBR established a Financial Markets Operations Committee (FMOC) to improve daily liquidity management and guide NBR interventions on money market.
In the same perception, the NBR also convenes quarterly discussions with commercial bank treasurers about market developments and analysis. In addition, the NBR introduced the bond reopening and the true repo mechanism to increase the trust of players on interbank market as all transactions are collateralized and ownership of security holders is fully transferred during the borrowing period. As a result of all these initiatives, the transmission mechanism from central bank rate to money market rates significantly improved, paving the way to the adoption of the new monetary policy framework.
The Monetary Policy Committee (MPC) processes have been revised.
As stipulated in the law governingthe NBR, the MPC is responsible for the formulation of a Monetary Policy in NBR. The committee meets once a quarter and whenever necessary upon invitation by the Governor. To ensure a successful price based monetary policy, in January 2019, the MPC adjusted its processes to fit the new framework that is more forward looking. Hence, the frequency of MPC preparatory meetings have increased, which continues to enhance a well-informed and forward-looking policy decision making.
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