Monetary policy, credit growth, and economic activity in Rwanda

Abstract

The successful conduct of monetary policy requires a thorough assessment of how changes in policy actions are
propagated to the real economy. We employ the Vector Autoregression (VAR) type of models to examine the effect of
monetary policy on goal variables, namely, credit, output, and inflation in Rwanda. The empirical findings from standard
VAR models show that the effect of the interbank rate on goal variables is consistent with theoretical propositions and
empirical applications. A positive shock to the interbank rate causes inflation to fall by about five percentage points
over eight quarters, and credit to fall by about four percentage points in the first four quarters. Consequently, economic
growth falls by about one percentage point. The Vector Error Correction (VEC) model shows that the previous quarter’s
deviation from long-run equilibrium is corrected for in the current quarter at an adjustment speed of 0.1%. These findings
remain robust when we apply a Structural Vector Autogressive (SVAR) model, and these models capture the essential
macroeconomic relations between a monetary policy indicator and goal variables, following the recent improvement in
financial markets.