Assessment of the interest rate and exchange rate channels of monetary policy transmission in Zambia: evidence based on SVAR approach

A structural vector autoregression (SVAR) based on quarterly data over the period 2000Q1-2015Q2 is employed to assess the interest rate and exchange rate channels of monetary policy transmission in Zambia. The model set up to assess the interest rate channel and exchange rate channel is based on the real business cycle new Keynesian monetary economics which assumes nominal and real rigidities. In this framework, the central bank can affect real output and inflation provided it can affect the real interest rate through the control of the nominal interest rate. Therefore, a SVAR in gaps consistent with real business cycle models with an optimal three lags is estimated and results indicate that tight monetary conditions lead to contracting economic activity and falling inflation. Other results show that real depreciation of the Kwacha leads to increasing inflation and decreasing economic activity conflicting the expenditure switching hypothesis. Further, historical decomposition of inflation indicate that the exchange rate has in the past been the most important variable explaining variations in inflation followed by economic activity and lastly interest rate fluctuations.