Interest Rate Channel and Monetary Transmission in Zambia

This paper analyses the monetary policy transmission in Zambia, with a particular focus on the interest rate channel. The study uses a VAR approach to estimate annual data from the year 1980 to 2011. The paper also employed time series techniques namely, unit root tests, cointegration, Granger causality test, impulse response and forecast error variance decomposition. The cointegration test showed that cointegration exists. Granger causality test showed a bi-directional causality between inflation and interest rate. There is a unidirectional causality running from gross domestic product to interest rate. The impulse response function indicated that output responded negatively to monetary policy, and the rate of inflation had an inverse relationship on the rate of interest. The forecast error variance decomposition showed that CPI was attributed to itself, while GDP was largely attributed to itself with a significant contribution to CPI and no contribution from the rate of interest. On the other hand, in forecasting the rate of interest, it was found that the rate of interest was largely attributed to itself, with a successive increase in CPI. The results provide evidence of the functional interest rate channel existence in the Zambian economy.