Divisia monetary aggregate and monetary transmission mechanism in the Democratic Republic of Congo (DRC)

ABSTRACT

While the majority on the effectiveness of monetary policies focus on either interest or money channels, we analyze the effectiveness of a composite monetary instrument: The Divisia Aggregate Index (DMAI). Dynamic effects of the DMAI on other economic factors is analyzed through the Factor Augmented Vector Autoregressive model (FAVAR). The latter address the potential arbitrary selection of variables to incorporate in a standard VAR model, and is built from the ability of factor analysis to summarize a very high number of variables into few factors. The FAVAR is applied to monthly data  over the period 01:1996-12:2017 from the Democratic Republic of the Congo. Our empirical results reveal that the DMAI outperforms other monetary policy instruments that use separately interest or money channels, in boosting output and triggering price stability.

KEYWORDS:

• Monetary policy
• divisia monetary aggregates
• FAVAR
• monetary transmission mechanisms

JEL CLASSIFICATION:

• C3
• E4
• E51
• E52
• E59
• F31
• F41

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ A policy instrument is effective when it helps the central bank to achieves its policy goals (output growth and price stability).

² Money-ness measures the liquidity of monetary assets. Currency and coin are the most liquid (hundred percent liquid) and other monetary assets are not hundred percent liquid.

³ Prices of monetary assets are measured by the user costs or the opportunity costs of holding the asset for its liquidity services rather than investing it to obtain a much higher interest rate (Barnett 1980).

⁴ Congolese economy depends mostly on its copper export.

⁵ The price puzzle occurs when the monetary policy shocks are identified as innovations in interest rates, an increase in the interest rate is associated with a persistent increase, rather than a decrease of the price level. The liquidity puzzle occurs when there is a positive shock to the monetary aggregates, the increase in monetary aggregates is associated with increases rather than decreases in nominal interest rates. The forward discount bias occurs when a positive shock in domestic interest rate relative to a foreign one is associated with a persistent appreciation, rather than depreciation, of the domestic currency for periods up to two years after the initial shock.