Revista Internacional de Economia e Ciências de Gestão

The Monetary Policy Frame Work of National Bank of Ethiopia

Abstract

Abera Fekadu Hailemariam

Monetary policy in a simplified analysis amounts to the determination of "optimal" quantity of money or in a dynamic sense the optimal growth rate of the money stock. Monetary policy also refers to how the central bank uses interest rates and the money supply to guide economic growth by controlling inflation and stabilizing currency (Islam, 2010). Central banks are the highest authority of the government who is responsible for formulation and implementation of monetary policy in a way to achieve certain economic objectives of a given country. National Bank of Ethiopia (NBE) is the government authority who is mandated to formulate monetary policy in Ethiopia (Monetary and Banking Proclamation of 1994). During the command economic era, monetary variables were under direct control of the government and banking sector is totally dominated by the public ownership. However, since the start of economic reform, the financial sector has undergone reforms and the private sector was allowed to invest in the sector (only for nationals). Consequently, private banks and insurances started to flourish soon after the enactment of a Monetary and Banking Proclamation of 1994. The reform enables the National Bank of Ethiopia to use indirect market based instruments along with direct instruments to control or influence the supply of and demand for money. In Ethiopia, a monetary policy frame work is set according to sequential set of action for designing and formulating monetary policy. The frame work is based on certain knowledge (assumption) of stable money demand function, transmission mechanisms and money supply process. The final targets of monetary policy in Ethiopia are to maintain price and exchange rate stability and support sustainable economic growth. In achieving these objectives, the NBE sets money supply as an intermediate target. The current target is to ensure that the money supply growth is in line with nominal GDP growth rate. The growth of base money/reserve money is being used as an operational target of the National Bank of Ethiopia. These intermediate and operational targets are connected with different policy instruments like Open Market Operation, A standing central bank credit facility, Reserve Requirement, setting of floor deposit interest rate (until interest rate is fully deregulated), Direct borrowing/lending in the inter-bank money market and introducing re-purchase agreement (repo/reverse repo operations), Use of selected credit control when necessary, and Moral Suasion. The recent history of Ethiopia provides abundant evidence on the role played by the monetary factors in the macro economy. It can demonstrate that changes in the money supply exert profound influence on inflation, output growth and other financial activities. Therefore, the success of monetary policy depends on the degree of predictability, measurability and controllability that the monetary authority has over money supply