## How Africa Can Navigate Growing Monetary Policy Challenges _IMF Blog, April 4, 2022_ ## Source details **Canonical URL:** [How Africa Can Navigate Growing Monetary Policy Challenges](https://www.imf.org/en/blogs/articles/2022/04/04/blog04042022-how-africa-can-navigate-growing-monetary-policy-challenges) ## Other formats - [Markdown version](/en/blogs/articles/2022/04/04/blog04042022-how-africa-can-navigate-growing-monetary-policy-challenges/index.md) - [Structured JSON version](/en/blogs/articles/2022/04/04/blog04042022-how-africa-can-navigate-growing-monetary-policy-challenges/index.json) - [Bundle manifest](/en/blogs/articles/2022/04/04/blog04042022-how-africa-can-navigate-growing-monetary-policy-challenges/bundle-manifest.json) ## Bibliographic details - Authors: Tobias Adrian, Gaston Gelos, David Hofman - Published: April 4, 2022 --- ### Context and key challenges - Sub-Saharan African countries face important monetary policy challenges following the pandemic: "the pandemic dented economic growth, and even now the recovery is likely to leave output below the pre-crisis trend this year." - Several countries in the region have seen inflation increase, sometimes compounded by "fiscal dominance emanating from high public debt levels." - Many economies may face capital outflows as "the major central banks in advanced economies withdraw policy stimulus and raise interest rates in the period ahead." - The conflict in Ukraine and the associated "sharp rise in energy and food prices" are likely to intensify these challenges. ### Exchange rate considerations and vulnerabilities - Countries with managed or free-floating exchange rate regimes generally benefit from allowing currencies to adjust while focusing monetary policy on domestic objectives. - Factors that can limit the benefits of fully flexible rates in many sub-Saharan African countries: - Dominant currency pricing (i.e., "rigid export prices in US dollar terms") can weaken trade adjustments from flexible rates. - Shallow markets (i.e., "markets with limited liquidity") can amplify exchange rate movements and yield excessive volatility; evidence includes "wide spreads between bid and ask prices." - High foreign-currency denominated liabilities lead to currency mismatches on balance sheets; exchange rate depreciations can "undermine the financial health of corporates and households." - Weak central bank credibility can cause exchange rate changes to have a bigger effect on inflation ("high passthrough"). - Consequences of these vulnerabilities: - Currency mismatches and high passthrough can cause "output and inflation to move in opposite directions following shocks," worsening policy tradeoffs. - There is evidence that "the exchange rate passthrough in low-income countries is substantially higher than it is in more advanced economies," problematic given heavy dependence on food and energy imports. ### Policy tools and near-term measures - Reducing vulnerabilities over time is important and includes: - Reducing balance sheet mismatches. - Developing money and foreign currency markets. - Reducing exchange rate passthrough by building monetary policy credibility. - "Many of these are areas where IMF technical assistance can help." - While vulnerabilities remain high, the IMF’s work toward an "Integrated Policy Framework" suggests additional tools can ease short-term policy trade-offs when certain shocks hit. When reserves are adequate and tools are available, the following can help: - Foreign exchange intervention. - Macroprudential policy measures. - Capital flow measures. - Expected short-term benefits from using these additional tools: - Enhance monetary policy autonomy. - Improve financial and price stability. - Reduce output volatility. - Model simulations cited suggest that in response to a "sharp tightening of global financial conditions or other negative external financial shock," a vulnerable country could improve immediate outcomes by using foreign exchange intervention to reduce exchange rate depreciation, thereby: - Limiting the inflationary impact. - Reducing negative balance sheet effects. - Resulting in "higher output and lower inflation than would have been feasible without the use of the additional policy instrument." ### Qualifications, risks, and communication challenges - Important qualifiers for central banks considering these policies: - Tools "should not be used to maintain an over- or undervalued exchange rate." - Benefits of additional tools must be weighed against potential longer-term costs, which may include "reduced incentives for market development and appropriate risk management in the private sector." - Communicating about the joint use of multiple tools "can be very challenging," and expanding policy options may expose central banks to political pressures. - Central banks need to consider potential negative impacts on "their own transparency and credibility, especially in circumstances where policy frameworks are not yet well established." ### Policy implications and priorities - Near-term: Consider limited, conditional use of foreign exchange intervention, macroprudential measures, and capital flow measures when reserves are adequate and vulnerabilities justify their use, to ease immediate trade-offs between output and inflation. - Medium- to long-term: Prioritize structural measures to reduce vulnerabilities: - Reduce currency and balance sheet mismatches. - Deepen money and foreign exchange markets. - Build central bank credibility to reduce exchange rate passthrough. - Leverage IMF technical assistance where relevant. - Ensure clear communication strategies and safeguard central bank transparency and independence when expanding the policy toolkit. *Tobias Adrian, Gaston Gelos, David Hofman — April 4, 2022* --- ## References - [https://www.imf.org/wp-content/uploads/2022/03/Blog-SSA-Charts-FX-v2.jpg](https://www.imf.org/wp-content/uploads/2022/03/Blog-SSA-Charts-FX-v2.jpg) - [https://www.imf.org/wp-content/uploads/2022/03/AFR-Chart-2-FX.jpg](https://www.imf.org/wp-content/uploads/2022/03/AFR-Chart-2-FX.jpg) - [Integrated Policy Framework](https://www.imf.org/en/Publications/Policy-Papers/Issues/2020/10/08/Toward-an-Integrated-Policy-Framework-49813) - [additional tools](https://blogs.imf.org/2020/07/13/toward-an-integrated-policy-framework-for-open-economies/) - [models](https://www.imf.org/en/Publications/WP/Issues/2020/07/07/A-Quantitative-Model-for-the-Integrated-Policy-Framework-49555) _Source: https://www.imf.org/en/blogs/articles/2022/04/04/blog04042022-how-africa-can-navigate-growing-monetary-policy-challenges_