Support to the Monetary Affairs Committee (MAC) of the East African Community (EAC)- 2

This paper was commissioned by the Economic Affairs sub-committee of the East African Community Monetary Affairs Committee. The paper offers a template for Partner State central banks to employ in developing common operational and analytical approaches to understanding the evolution and behaviour of the money multiplier in the context of reserve money-based monetary programmes.

Excerpt from introduction:

This paper discusses the stability and predictability of the money multiplier in the context of a reserve money anchor for inflation. The methods are illustrated throughout using data from Tanzania, but the discussion is relevant for the whole of the East African Community. The money multiplier is a measure of the leverage of a country’s banking system, in other words the extent to which fractional banking activities produce ‘inside’ money (i.e. the monetary liabilities of the banking system) from ‘outside’ or base money (i.e. the primary monetary liabilities of the central bank). Defined as the ratio of the money supply to base money, the multiplier plays a central role in the monetary policy frameworks in all the EAC members.

All five countries seek to anchor inflation around a target rate by influencing the growth rate of (some measure of) broad money. This intermediate target is, in turn, pursued through policy actions designed to influence the path of reserve money. Successful targeting of broad money therefore depends on the existence of a stable relationship between it and base money. It follows there exists a different multiplier for each definition of the money supply. For the East African Community the two relevant multipliers are those relating M2 to base money and M3 to base money.

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