Monetary policy and financial frictions in a small open-economy model for Uganda

Abstract

This paper considers the role of financial frictions and the conduct of monetary policy in Uganda. It makes use of a dynamic stochastic general equilibrium model, which incorporates small open-economy features and financial frictions that are introduced though the activities of heterogeneous agents in the household. Most of the parameters in the model are estimated with the aid of Bayesian techniques and quarterly macroeconomic data from 2000q1 to 2015q4. The results suggest that the central bank currently responds to changes in the interest rate spread, despite the fact that capital and financial markets are relatively inefficient in this low-income country. In addition, the analysis also suggests that to reduce macroeconomic volatility, the central bank should continue to respond to these financial sector frictions and that it may be possible to derive a more favourable sacrifice ratio by making use of a slightly more aggressive response to macroeconomic developments.