Determinants of money supply in Rwanda

Abstract

Before mid 1990s economic reforms, the National Bank of Rwanda had the task of implementing monetary policy and supporting government policies including financing government debt. Since the implementation of reforms, the financial sector has evolved and the National Bank of Rwanda has adopted an indirect monetary policy. Whether the National Bank of Rwanda can exogenously determine money supply and what are the main determinants of money supply in Rwanda, are empirical questions. The main objective of this study was to investigate the main determinants of money supply in Rwanda. The specific objectives were to: determine the effects of domestic credit to government on money supply; examine the effect of net foreign assets on money supply; and test for endogeneity\exogeneity of money supply in Rwanda. Using monthly data from January 1995 to September 2009, results from cointegration analysis revealed that net domestic credits to banks, net foreign assets and domestic credit to government have a significant positive influence on M2. Moreover, results from Granger causality test and cointegration technique confirmed the Post Keynesians endogenous money hypothesis in the short run while in the long run results were mixed between Monetarists’ exogenous money hypothesis and Post Keynesians endogenous money hypothesis. Generally the findings show that the banking sector is a key player in money supply process and a more effective monitoring of financial institutions is needed to ensure an efficient money supply management in Rwanda.