Do Monetary Policy Frameworks Matter in Low-Income Countries?

Abstract

In recent years, most low-income countries (LICs) have been remarkably successful in reducing inflation to single-digit levels, and many LICS are engaged in reforms to make their monetary policy frameworks more systematic, transparent, and forward-looking, often with technical support from the International Monetary Fund (IMF). To inform those initiatives, our paper provides new empirical evidence about how the characteristics of the monetary policy framework affects the propagation of shocks in LICS. First, we analyze a cross-country panel dataset of 79 LICs over the period 1990 to 2015 to assess the impact of external shocks on real GDP growth, and we find highly significant differences between LICs where the central bank targets monetary aggregates or inflation compared to LICs that use the nominal exchange rates as the main nominal anchor. Second, we use difference-in-difference methods to assess the evolution of economic growth in sub-Saharan Africa (SSA) over the period from 1986 to 1994, and we find highly significant differences between 9 countries in the Central African Franc (CFA) zone compared to a control group of 12 other SSA countries. Our findings show that central banks in LICs can face policy tradeoffs similar to those which have been highlighted for more advanced economies, and our analysis underscores the key role of the monetary policy framework in fostering price stability and sustained economic growth in LICs.