Monetary Conditions Index and Economic Activity in Dollarized Zimbabwe

Purpose: Zimbabwe has experienced a chronic inflationary crisis whose roots can be traced back to 1997. Various macroeconomic instruments have been suggested to stabilize the country’s prices and foster economic growth but evidence on how they interplay to influence policy is lacking. This study developed a monetary conditions index (MCI) for Zimbabwe during the 10-year dollarization period, 2009 to 2018, and measured its correlation with economic activity. The aim of the MCI is to inform monetary policy making in Zimbabwe. Design/methodology/approach: Using monthly time series data, the MCI series from 2009 to 2018 was calculated using real interest rates and exchange rates. The relationship between the MCI, GDP, inflation, money supply and private sector credit was analysed using the Auto Regressive Distributed Lag (ARDL) model for the long-term relationship and Granger causality for the short term. Findings: Results showed MCI weights of 1:1.54 implying that exchange rates dominate the interest rate in Zimbabwe’s monetary policy. A long run relationship between the MCI and economic variables was statistically significant while short term relationships were established for private sector credit, GDP, and foreign interest rates. Research implications: The study concludes that the MCI is a useful indicator of the central bank’s monetary policy positionfor economic analysts while the central bank can also adopt it for inflation and growth targeting. Originality/value: Unlike previous research which has proffered monetary solutions based on specific variables, this study took into consideration the interplay between interest rates and exchange rates in determining economic activity in Zimbabwe. The constructed MCI captured the interplay between these two key variables and the study established its relationship with economic activity. On this basis, the study recommends the adoption of the MCI in guiding monetary policy in Zimbabwe.