Chapter 6: Monetary Policy in Ethiopia

 The financial history of Ethiopian shows that following the

nationalization of private banks and other financial
institutions in 1974 there were only few government banks
operating throughout the country till 1994/5 namely
Commercial Bank of Ethiopia, Construction and Housing
Bank and Agricultural and Development Bank.
 During this period the National Bank of Ethiopia conduct
its monetary policy by directly controlling monetary
variables and prices.
 The NBE set the interest rate structure in such a way that it
discourages private sector and favors public institutions
and specially cooperatives and associations
 Monetary Policy in Ethiopia…..

 After the change of government in1991, the private

sector was given emphasis and the government started
to withdraw from the market step by step by privatizing
its enterprises.
 This was part of the general economic liberalization
process, which also touched the financial sector.
Accordingly, NBE was restructured in a manner to
conduct monetary policy independently and supervise
financial institutions in the country
 Monetary Policy in Ethiopia…..

The role of NBE in the financial sector grew following the

establishment of private banks and insurances.
 The slipping away of direct control power on money
supply and the unpredictability of the private sector
necessitated indirect controlling mechanism of money
supply.
The principal objective of the monetary policy of the NBE is
to maintain price & exchange rate stability and support
sustainable economic growth of Ethiopia.
 Monetary Policy in Ethiopia…..
Price stability is a proxy for macroeconomic stability which
vital in private sector economic decision on investmen
consumption, international trade and saving.
Finally, macroeconomic stability fosters employment a
economic growth.
Maintaining exchange rate stability is the principal poli
objective of NBE so as to be competitive in the internation
trade and to use exchange rate intervention as policy tools f
monetary policy to affect both foreign reserve position a
domestic money supply.
 More specifically, the objectives of Ethiopia’s monetary
policy are to

 Foster monetary, credit and financial conditions

conducive to orderly, balanced and sustained economic
growth and development.
 Preserve the purchasing power of the national
currency – ensuring that the level of money supply is
generally consistent with developments in the macro-
economy and intervening in the foreign exchange rate
market for the purpose of stabilizing the rate when
conditions necessitate.
 More specifically, the objectives of Ethiopia’s monetary
policy are to

 Encourage the mobilization of domestic and foreign

savings and their efficient allocation for productive
economic activities through the implementation of a
prudent market driven interest rate policy.
 Facilitate the emergence of financial and capital
markets that are capable of responding to the needs of
the economy through appropriate policy measures.
 These measures would ensure the gradual introduction
of trading instruments on a short-term basis.
 6.1 Powers and Functions of the National Bank of
Ethiopia

 There is no any hard and fast rule regarding functions of

a central bank.
 The range of functions of central bank varies from
country to country. However, there are certain functions
commonly performed by of the national banks. These
are:
 6.1 Powers and Functions of the National Bank of
Ethiopia…..
1. Currency (Note) Issue:- One of the major functions o
central bank is the issues of currency note.
 The main reason why note issue function is concentrated in
a central bank is that.
 It will bring about uniformity in currency circulation.
 It enables central bank to control lending operation o
commercial banks and thereby controls the circulation o
money in the economy.
 It gives the NBE the power of monetary management in the
 6.1 Powers and Functions of the National Bank of
Ethiopia…..

ii. Bank of the government: - The National bank of Ethiopia

acts as a bank, agent and advisor to the government as a
government bank, it keeps the banking account of the
different government departments.
In keeping the banking account of the government, the
central bank functions as an ordinary commercial bank.
It accepts deposit of cash, checks, and draft on behalf of the
government and undertakes the collection of check and drafts.
 6.1 Powers and Functions of the National Bank of
Ethiopia…..
iii. Bankers of bank (bank of banks):- Central bank
supervises and monitors the activity of commercial
banks. Central bank as bankers of bank performs the
following functions.
It acts as a guardian of cash reserve of commercial banks.
 That is, commercial banks deposit their excess reserve
with the central bank.
It acts as a clearing house for settling the interbank
financial movements (debts)
 6.1 Powers and Functions of the National Bank of
Ethiopia…..
Iv Lender of the last resort:- The national bank is th
ultimate source of cash to the banking system, Whenever a
individual bank is in need of cash to meet any emergencies
the bank can approach the central bank.
In other words any commercial bank wanting for financia
assistance from the central bank can borrow from the centra
bank against eligible securities.
 By acting as the lender of last resort, the NBE’s th
elasticity and liquidity of the banking system.
 6.1 Powers and Functions of the National Bank of
Ethiopia…..

V. Custodian of foreign exchange reserve:- It keeps the

national reserve of foreign currency.
 It has the responsibility of safeguarding the value of the
national currency and maintaining the monetary
standard.
 It will maintain stability of exchange note by
maintaining the external value of the currency.
 6.1 Powers and Functions of the National Bank of
Ethiopia…..

•vi. Developmental and promotional function: - like:

 Encouraging the banking habit or using banking system
for any financial transactions among people.
 Encouraging the development of saving habits among
people
 Establishing specialized financial institutions
 Conducting research and surveys in banking
 Devising new schemes for the development of banking
system.
 6.2 Conduct of Monetary Policy in Ethiopia

 Monetary policy strategy of a central bank depends on a

number of factors that are unique and contextual to the
country.
 Given the policy objective, any good strategy depends on
the macroeconomic and the institutional structure of the
economy.
 An important factor in this context is the degree of
openness of the economy.
 6.2 Conduct of Monetary Policy in Ethiopia……

 The more open the economy is, the more the external
sector plays a dominant role in monetary management.
 Within a country’s monetary management framework,
there are basically three targets: the ultimate or final
target, the intermediate target and the operating target
 Final and intermediate targets of NBE :

 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. It should be noted that
intermediate targets are not directly controlled by the
central bank.
 Traditionally, money supply is defined from its narrow
and broader sense
 Final and intermediate targets of NBE …

 Narrow money C+D (M1) is a measure of money stock

intended primarily for use in transactions.
 Broad Money (M2) is a measure of the domestic money
supply that includes M1 plus Quasi-money (savings and
time deposits), overnight repurchase agreements, and
personal balances in money market accounts.
 NBE takes the broader definition of money or M2 as
money supply. The current target is to ensure that the M s
growth is in line with nominal GDP growth rate
 Operational target of NBE
:

 They can be used to link instruments of monetary policy

to intermediate targets set by the central bank and
represent the first impulse in the transmission process of
monetary policy.
 The growth of base money/reserve money is being used
as operational target of the National Bank of Ethiopia.
 The practice of targeting reserve money is based on the
assumption that there will be a stable money demand
function in the economy.
 Operational target of NBE….
:

 If the money demand happens to be unstable over the

medium to long term, then the NBE will shift its targeting
in to another workable framework such as interest rate
targeting or multiple indicator approach
 Monetary Policy Instruments used by NBE

 The introduction of a wide range of monetary instruments

by central banks stimulates competition, efficiency and
transparency and broadens financial intermediation in the
banking system.
 So far, the use of such instruments has been extremely
limited in Ethiopia due to the underdevelopment of the
money market and the virtual non-existence of a financial
market
 Monetary Policy Instruments used by NBE

 Thus, it is envisaged to use a mix of diversified

monetary policy instruments so as to effectively carry out
the monetary management function of the NBE.
 A standing central bank credit facility
 This instrument used to enhance the financial capacity of
commercial banks and to promote financial
intermediation and efficiency.
 The key advantages of such standing credit facility are
transparency and predictability of accessing central
banks’ resources to cover short-term needs.
 This credit facility gives banks an assurance that, when
confronted with problems of shortfall in the clearing and
a lack of alternatives for raising immediate funds.
 Reserve Requirement
 The requirement is currently 5 percent of the net deposit
and failing to comply with this requirement will be
penalized.
 The NBE uses this instrument to control the liquidity of
banks by varying the rate according with the targeted level.
 The higher Reserve Requirement contracts the liquidity as
well as credit expansion power of commercial banks and
the opposite will increase liquidity and credit expansion
power of banks.
 Other monetary policy instruments used
 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 End

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