Fiscal and Monetary Policy Coordination in the WAMZ: Implications for Member States’ Performance on the Convergence Criteria

  • Abwaku Englama
  • Abu Bakarr Tarawalie
  • Christian R. K. Ahortor
Part of the Advances in African Economic, Social and Political Development book series (AAESPD)


There have been persistent high fiscal deficits, inflation and interest rates in Member States of the West African Monetary Zone (WAMZ). Thus, inflation and fiscal deficit criteria are the most difficult to satisfy in the Zone. This study, therefore, seeks to investigate the level of coordination between the fiscal and monetary authorities in each of the WAMZ countries and its implications for the attainment of the inflation and fiscal deficit criteria. To achieve this objective, the study utilizes the Set Theoretic Approach (STA) and the vector autoregressive (VAR) modelling to estimate the degree of policy coordination in the Zone. Under the STA, coordination exists when shocks to policy goals elicit prudent policy responses. In case of the VAR, the strength of coordination is measured by the impulse responses of fiscal and monetary policy variables to innovations in inflation, output gap and exchange rate. Both the STA and VAR estimations made use of annual data for the period 1980–2011. The study finds that there were weak policy coordination and insufficient policy prudence in all the WAMZ countries during the study period, contributing to the non-compliance with inflation and fiscal deficit criteria. The key recommendation is that WAMZ countries should strengthen policy coordination by putting in place formal coordination platforms and institutional arrangements for timely and adequate statistics, binding commitments and effective monitoring and evaluation of policy outcomes.


Fiscal and monetary policies Policy coordination Set theoretic approach Vector autoregressive model West African Monetary Zone 

1 Introduction

The objective of monetary and fiscal policies is to achieve stable and non-inflationary economic growth. Achieving price stability and economic growth is dependent upon the degree of monetary and fiscal policy coordination. Fiscal policy is essentially related to taxation and spending decisions of government, while monetary policy encapsulates those decisions bordering on money supply and interest rate in a given economy. The overarching objective of fiscal policy is to reduce unemployment rate by creating environment where all available resources in the economy will be gainfully employed to produce increased output. With regard to monetary policy, the overriding objective is to maintain price and exchange rate stability by ensuring that money supply growth does not go out of control in relation to macroeconomic fundamentals. The ultimate objective of both policies is to maximize the overall welfare of the society which can be achieved by keeping the inflation rate low and employment at its potential level. Economic theory postulates that these two objectives are not mutually exclusive since the attainment of one has implications for the attainment of the other. Thus, strict adherence to “separation of powers” in the management of the economy will cause degeneration in the economy as fiscal and monetary authorities pursue genuinely and rigorously their system-derived objectives. This implies lack of policy coordination may result in serious economic dislocations even when it appears fiscal and monetary authorities are achieving or close to achieving their objectives.

One of the major challenges facing the countries of the WAMZ is the issue of fiscal dominance, which has resulted in most countries recording huge fiscal deficit—to—GDP ratios in excess of the WAMZ benchmark. Financing of such deficits over the years has led to inflationary spiral, as most countries registered double digit inflation rates, exceeding the single digit criterion. To ensure the satisfactory achievement of the convergence criteria on fiscal deficit/GDP and inflation, there is a need for policy coordination between the monetary and fiscal authorities. This arises because individual policy instruments typically have an impact on more-than-one policy targets. Although they can help policymakers achieve a desired value for one policy target, they may disrupt the attainment of a desired value for other policy targets. This creates interdependencies in the pursuit of policy objectives. On the one hand, fiscal policy influences price developments, real interest rates, exchange rates as well as aggregate demand and potential output. Thus, increase in budget deficit may affect overall policy credibility. On the other hand, monetary policy has an impact on exchange rates, inflation expectations and short-term interest rates, which have a significant impact on interest rate expenditure and consequently increases government budget deficit. The reaction function of the government may impair monetary policy implementation. Thus, there is a strong need for coordination of monetary and fiscal policies.

This study, therefore, seeks to investigate the level of coordination between the fiscal and monetary authorities in each of the WAMZ countries. To achieve this objective, the study utilizes the set theoretic approach to compute policy coordination and policy prudence scores for the WAMZ countries. A vector autoregressive (VAR) modelling technique is also employed to estimate the impulse response functions that help in assessing the strength of fiscal and monetary policy responses to shocks emanating from inflation and output gap, where fiscal deficit, money supply growth and exchange rate depreciation are considered as policy variables.

Following this introduction, the rest of paper is organized as follows: Sect. 2 presents the background to the study by discussing the institutional arrangements for policy coordination in the WAMZ. Section 3 provides a review of the theoretical and empirical literature, while Sect. 4 presents the theoretical framework, model specification and data description. Empirical results are presented and discussed in Sect. 5, while Sect. 6 summarises the findings and proffers policy recommendations.

2 Background: Institutional Arrangements in the WAMZ

2.1 The Gambia

Monetary Policy

The primary objective of monetary policy in The Gambia is price stability. The Central Bank of The Gambia (CBG) is also mandated to promote and maintain the stability of the local currency as well as regulate the financial system to ensure efficient utilisation of resources and sustainable economic development of the country. The Bank has been granted significant operational but not goal independence in the conduct of monetary policy. It has monetary-targeting framework. The monetary policy decision making function is exercised through the Monetary Policy Committee (MPC) which meets bi-monthly to review developments in the economy and make pronouncements that set the policy and rediscount rates. The CBG primarily uses of Open Market Operations (OMO) to manage liquidity in the banking system through the weekly issuance of treasury and central bank bills. Required reserves ratio is also prescribed both for prudential and liquidity management purposes. The primary dealers are the commercial banks through which institutions and individuals could participate in the auctions. Secondary market sales and purchases of the instruments are undertaken at the special window at the CBG. The Bank only intervenes in the foreign exchange market to smoothen short term fluctuations rather than as an explicit tool for liquidity management. Evolution of broad money supply and inflation during the study period is summarised in Fig. 1.
Fig. 1

The Gambia—trends in M2 growth and inflation, 1980–2011

Fiscal Policy

The fiscal policy objective in The Gambia is to encourage public and private sector investment to support high economic growth on the background of fiscal consolidation. The Ministry of Finance and Economic Affairs (MFEA) of The Gambia has the responsibility of defining the Government of The Gambia’s overarching macroeconomic policy objectives and the frameworks in pursuit of these objectives. The implementation framework places particular emphasis on transparency in government fiscal operations, debt sustainability. broad-base participation of stakeholders including the CBG, Gambia Bureau of Statistics and development partners such as the IMF and World Bank, and enhancement of capacity in the development of MTDS and the assessment of debt portfolio risks. The MFEA has exclusive responsibility for budget formulation and implementation and domestic debt policy. The main objective of domestic debt management is “to meet the public sector borrowing requirement (PSBR) at a minimum long-term cost and acceptable risk”. The debt management strategy is based on the MTDS covering the period 2011–2014. The country’s macroeconomic programme, the Extended Credit Facility with the IMF, also lays emphasis on containment of the domestic debt. Figure 2 illustrates trends in key fiscal and real sector outcomes.
Fig. 2

The Gambia—trends in fiscal deficit and real GDP growth, 1980–2011

Policy Coordination

Apart from the IMF supported Extended Credit Facility being implemented by the country, coordination of fiscal and monetary policies in The Gambia is carried out under elaborate institutional arrangements. These are stipulated under a Memorandum of Understanding (MOU) signed between the CBG and MOFEA on the Domestic Debt Management and Monetary Operations in the 2007. The MOU allocates roles and responsibilities to both institutions in order to ensure accountability and responsibility for its actions in their respective areas of responsibility. Thus, the guiding principles include clear lines of responsibility, avoidance of duplication efforts, coordination of policies to ensure synergy, and information sharing. The policy coordination takes place at the different levels under the following committees: (1) the Macroeconomic Committee (MC) which brings together the Minister of Finance and the Governor of the Bank and chaired by the Minister of Finance. It meets on a quarterly basis or as often as necessary at the request of any of the parties; (2) the Monetary Policy Committee of the CBG (MPC) which meets at 2-month intervals to pronounce on the monetary policy stance of the Bank. The MPC is chaired by the Governor of the CBG with Ministry of Finance represented by two officials as ex-officio members. Signalling of the policy stance is communicated through announcements by the MPC regarding changes to its rediscount rate; and (3) the Treasury Bills Committee of the CBG that meets weekly to conduct the auctions. To assist in the coordination of fiscal and monetary policy and liquidity management in pursuit of its price stability objectives, the MFEA undertook to provide weekly forecasts of the budget deficit financing requirements to the CBG. This also helps the CBG to monitor compliance with respect to the statutory limits set on Government borrowing from the CBG in particular.

2.2 Ghana

Monetary Policy

The monetary policy objective of the Bank of Ghana (BOG) is to ensure price stability—low inflation—to support other macroeconomic objectives including those for growth and employment. Price stability is defined by the Government’s inflation target. This target is revised annually and spelt out clearly in the budget statement for each fiscal year. The BOG has an inflation-targeting monetary framework with clear outlines on policy goals, regime, conduct and communication. The desired inflation target of below 10.0 % is expressed in terms of an annual rate of inflation based on the Consumer Prices Index (CPI) (See Fig. 3 for trends in inflation and M2 growth in Ghana). Although the Bank is not bound by law to explain to the Ministry of Finance or to Parliament if the target is not achieved, the Governor may be summoned to the Finance Committee of Parliament to explain developments within the economy. The inflation targets usually have allowance for minimal deviations resulting from shocks that cause uncertainty and volatility in the economy. Monetary policy conduct is the responsibility of the Monetary Policy Committee (MPC) adjusts interest rates so that inflation can be brought back to target within a reasonable period of time without creating undue instability in the economy. The Bank uses multiple instruments in achieving its policy objectives, which include the monetary policy rate, reserve money, required reserve ratio, and open market operations.
Fig. 3

Ghana—trends in M2 growth and inflation, 1980–2011

In conducting monetary policy, the MPC meets bi-monthly to review macroeconomic developments and set interest rates that will ensure attainment of the government’s inflation target. The MPC is chaired by the Governor of the Bank of Ghana and consists of seven members—five from the Bank of Ghana including the Chairman and two external members appointed by the Minister of Finance. The bi-monthly MPC meetings are for 3 days, usually beginning on the third Tuesday of the month in which the meetings have been scheduled and ending on the Thursday of that same week. Decisions are made by a vote of the Committee on a one-person one-vote basis with each member stating clearly the reasons for a particular interest rate decision. This is usually announced on a Monday following the Friday on which meetings normally become conclusive. Though the minutes of the meetings are not published a wide range of economic reports are made available at the Bank of Ghana website 2 weeks after the announcement of the interest rate decision.

Fiscal Policy

Ghana’s fiscal policy goals are, among others, to improve fiscal resource mobilization; allocate and manage financial resources efficiently, effectively and rationally; reduce the debt burden; and strengthen the private sector. Hence, the fiscal policy framework is designed to ensure macroeconomic stability for sustained economic growth and development (see Fig. 4 for evolution of real GDP growth and fiscal deficit in Ghana). The key features of the fiscal policy framework include the formulation and implementation of sound financial, fiscal and monetary policies; establishing and disseminating performance-oriented guidelines and accurate user-friendly financial management information systems; and creating an enabling environment for investment. The government fiscal policy stance has reflected the political business cycles experienced since the promulgation of the fourth republican constitution in 1992. Government’s fiscal consolidation programmes have been occasionally truncated especially in election years. Although domestic revenue targets are realised most of the times; expenditure overruns, especially, in areas of emoluments and transfers have often led to the continuous deterioration of the fiscal position.
Fig. 4

Ghana—trends in fiscal deficit and real GDP growth, 1980–2011

The government debt burden reduced after the completion of the HIPC initiative in 2002/2003. The total stock of debt has hovered around 40.0 % of GDP and proportionately split between domestic and external sources. However, in recent times, the country’s debt profile has been rising with increases in the provision of socio-economic infrastructure. To avoid a relapse into the experiences of the pre-HIPC era, the government is putting emphasis on the use of public-private partnership (PPP) schemes for roads and other economic infrastructure projects on build-operate- and-transfer (BOT) basis.

Policy Coordination

Although policy coordination has not yet been formalised, there are some platforms for broad policy discussions and consultations. The key committees whose functions have some coordination elements include the Economic Management Team (EMT), Monetary Policy Committee (MPC) and the Treasury Committee. The EMT is chaired by the Vice President of the Republic and comprises the Finance Minister, the Governor of BOG and other economic advisors appointed from outside government. They deliberate on wide issues relating to economic growth and stability but not necessarily harmonisation of policies. Further, the MPC has Finance Ministry’s representation which together review macroeconomic fundamentals before taking interest rate decisions that they deem to be consistent with government growth and inflation objectives. The government budget process is broad-based and consultative with inputs from the BOG, business community, academia and civil society organisations. After the formulation of the budget, it is submitted to Parliament (The Legislature) where it goes through the scrutiny of the Parliamentary Select Committee on Finance before final approval by the entire house. However, while a lot of consultations go into the fiscal policy formulation, its implementation is left in the hands of only the officials of the Finance Ministry. The Finance Minister is summoned occasionally by Parliament to explain some fiscal outcomes.

2.3 Guinea

Monetary Policy

The objective of monetary policy in Guinea is price stability to support economic growth. The country is currently implementing monetary-targeting framework. The Central Bank of Guinea (BCRG) is independent as enshrined in the Central Bank Act of 1995. There is a Monetary Policy Committee (MPC), comprising only central bank officials, which takes monetary policy decisions. In its policy implementation, the Central Bank focuses on low inflation as its ultimate goal and broad money supply growth as its intermediate target which is to be achieved through adjustments in the reserve money. These targets are set periodically by the MPC and the policy instruments such as the policy rate, required reserves and Open Market Operations (OMO) through both central bank bills and treasury-bills which are chosen based on the rate of inflation, banking system liquidity and credit as well as inflationary expectations. The required reserve ratio and the policy rate had been very effective. This is supported by the fact that during the period 2011–2012, the increase in the policy rate and required reserve ratio saw inflation decline from 20.8 % in 2010 to 12.8 % at end 2012 (see Fig. 5 for trends in broad money supply growth and inflation in Guinea during the study period).
Fig. 5

Guinea—trends in M2 growth and inflation, 1988–2011

Fiscal Policy

The thrust of fiscal policy is to stabilise the macroeconomic environment and boost economic growth by reducing the fiscal deficit and increasing public investment (see Fig. 6 for trends in fiscal deficit and real GDP growth in Guinea). In terms of debt management, the focus is on finding external funds at concessional rates and limiting domestic borrowing from the BCRG. The key features of the fiscal policy framework are measures to increase revenue mobilisation, expenditure management and improvement to ensure poverty reduction, as well as reducing fiscal deficit and public debt. The revenue mobilisation strategy envisages increased revenue/GDP ratio, increasing the tax base, reinforcing the capacity of small and medium enterprises, reviewing the investment and mining codes, and revising some mining agreements. To reduce expenditure, the authorities planned reducing central bank’s net claim on government, limiting borrowing from the commercial banks and putting in place cash budgeting.
Fig. 6

Guinea—trends in fiscal deficit and real GDP growth, 1988–2011

Policy Coordination

Although there is a platform for the coordination of monetary and fiscal policies in the country, it has not been formalised. This platform includes a Ministerial Committee involving Ministries of Finance, Mining and Trade and the BCRG and is chaired by the Advisor to the President and meets regularly. The coordination usually takes place at both the formulation and implementation stage of the IMF programme and the policy decisions of the ministerial committee are binding on all the relevant agencies. Coordination at this level has been effective in achieving some results such as the targets relating to the decision and completion points of the HIPC Initiative and the country programme with the IMF. Further, there is a Treasury Committee with BCRG representation and meets periodically. There is also COFIP which is a Fiscal Committee set up with BCRG’s representation to monitor or coordinate a country programme with the IMF.

2.4 Liberia

Monetary Policy

The focus of monetary policy in Liberia is on maintaining price stability. The Central Bank of Liberia (CBL)’s monetary policy framework is an exchange rate—targeting regime which aims at containing volatility in the exchange rate while building up foreign exchange reserves. As enshrined in the CBL Act of 1999, Part II No. 4 & 5, “The Central Bank shall have functional independence, power and authority” to carry out its functions under the supervisory oversight of its Board of Directors. The policy tools of the Bank include periodic foreign exchange auction and the recently launched Treasury bill market which is intended to widen the monetary policy space. As the major monetary policy tool available to it, the CBL uses its periodic foreign exchange auction to influence fluctuations in the exchange rate. Through weekly auctions and “special window”, banks, registered business institutions and individuals are allowed to participate through their respective banks. The Liberian economy is highly dollarized and cash based with a dual currency system. Thus, while the official currency is the Liberian dollar, the US dollar also remains legal tender. Figure 7 presents evolution of reserve money growth and inflation in Liberia during the study period.
Fig. 7

Liberia—trends in reserve money growth and inflation, 1980–2011

Fiscal Policy

Liberia’s fiscal policy aims at achieving strong and sustained economic growth, poverty reduction, efficient service delivery and resource mobilization with the intent to increase investments and enhance wealth distribution, as stipulated in the “Agenda for Transformation (AfT)”. Liberia has a well developed Medium Term Expenditure Framework (MTEF) as a means of executing multi-year development plans. The MTEF process has three main objectives: to ensure fiscal discipline by operating within budget; allocate resources in line with national priorities and; to ensure the efficient and judicious use of resources. The major development in fiscal management in recent years was the successful implementation of a cash-based budget to achieve fiscal discipline, which resulted in the successful achievement of the HIPC completion point in 2007. The key fiscal policy instruments are: taxes, expenditure and deficit financing (debt), grants and contingency funding. The emphasis is on resource mobilization through taxes and grants to finance government programmes. The country is operating a cash-management aimed at expenditure rationalization on recurrent expenditure, especially on wages and salaries; travels by government officials, goods and services. Evolution of real GDP growth and fiscal deficit/surplus in Liberia is captured in Fig. 8.
Fig. 8

Liberia—trends in fiscal deficit and real GDP growth, 1980–2011

Policy Coordination

The role of policy coordination is undertaken by several committees including the Economic Management Team (EMT) and Debt Management Committee (DMC). The EMT is the highest body responsible for coordinating fiscal and monetary policies. It is chaired by the President of Liberia and comprises Ministers of Finance, Commerce, and Justice and the Executive Governor of the CBL. The EMT meets once a week to discuss issues on macroeconomic developments, especially, in the areas of fiscal, monetary and exchange rate developments, among others. Decisions of the EMT are implemented by the Central Bank and Ministry of Finance. The DMC is chaired by the Minister of Finance and comprises officials from the CBL, Ministries of Justice and State for Presidential Affairs. It assesses public debt in terms of its sustainability, by ensuring that any new borrowing conforms to the guidelines set by the Debt Management Unit. The Committee also analyses debt in relation to the overall economic strategy, including its impact on inflation, interest rates and debt servicing.

2.5 Nigeria

Monetary Policy

The monetary policy thrust of the Central Bank of Nigeria (CBN) is to ensure optimal supply of liquidity to the economy to sustain price stability and non-inflationary economic growth. In line with this, the CBN has been tightening its monetary policy stance over the last 5 years in order to moderate inflation expectations, relieve pressure on the exchange rate and improve the returns on domestic financial assets (see Fig. 9 for evolution of reserve money growth and inflation in Nigeria). The CBN’s monetary policy framework is a monetary–targeting regime anchored on monitoring of monetary aggregates and inflation developments, liquidity management, fiscal-monetary policy coordination and communication with the market/public. It has the policy rate as operating target, broad money supply as intermediate target and single-digit headline inflation as the ultimate target. The CBN enjoys operational but no goal independence in the conduct of monetary policy as conferred on it by the CBN Act of 2007. The inflation target is set jointly by the CBN and the Ministry of Finance, while the exchange rate band is set by the CBN. With regard to policy instruments, the CBN deploys instruments including cash reserve requirement, monetary policy rate (MPR), liquidity ratio (LR), net open position limit (NOP), exchange rate and open market operations (OMO). These instruments are chosen individually or combined by the MPC based on the level of liquidity in the market, the pressure on the exchange rate, effectiveness of the instrument in liquidity management, and the purpose of the monetary policy measure whether it is for signalling or for actual injections/withdrawals.
Fig. 9

Nigeria—trends in reserve money growth and inflation, 1980–2011

Fiscal Policy

The thrust of fiscal policy in Nigeria is to encourage investment in specific sectors of the economy, boost public sector revenue, leverage on public sector funding of infrastructure through public-private partnerships (PPP) arrangements, and reduce borrowing. The fiscal policy framework is enshrined in the Fiscal Responsibility Act of 2007 with focus on macroeconomic stability and growth promotion (Fig. 10), sustainability of deficit and debt, increased capital spending in proportion of total spending, and servicing of external debt. The key fiscal policy instruments are taxation and government expenditure. Targets are set for revenue agencies such as Federal Inland Revenue Service (FIRS) and Nigerian Customs Service (NCS). As part of government expenditure rationalization strategy, budget envelopes are given to all ministries, departments and agencies (MDAs).
Fig. 10

Nigeria—trends in fiscal deficit and real GDP growth, 1980–2011

The Federal Executive Council (FEC) in 2010 adopted a more restrictive debt management framework in order to avoid a relapse into debt burden experiences prior to the debt relief of 2005/2006. The key features of the debt management framework are medium-term debt management strategy, domestic and external borrowing guidelines, annual borrowing programme and the quarterly debt issuance calendar. The debt management strategy is to ensure efficient public debt management in terms of comprehensive well-diversified and sustainable portfolio, supportive of government and private sector needs. In this regard, the Debt Management Office (DMO) prepares annual debt sustainability analysis (DSA) as a major debt management tool, using macroeconomic and debt data to assess the country’s debt sustainability in line with global debt burden and country specific thresholds.

Policy Coordination

Communication between fiscal and monetary authorities is done at various levels: first, bilateral communication between heads of the fiscal and monetary institutions and, secondly, through various formal committee meetings. The policy coordination framework has the fiscal and monetary authorities making inputs into major policy documents/issues including the budget, DSA, TSA, among others. For instance, the Federal Ministry of Finance is represented on the Monetary Policy Committee of the CBN. There are also formal committees where policy issues are discussed and harmonised where possible. These include Monetary and Fiscal Policy Coordination Committee (MFPCC), Cash Management Committee (CMC) and Fiscal and Liquidity Assessment Committee (FLAC). MFPCC meets on quarterly basis, MPC meets bi-monthly and CMC meets every month, while FLAC meetings are weekly. Further, meetings and other activities such as workshops and seminars are also held on a need basis.

The MFPCC was established on October 13, 2004 for the purpose of creating a platform for the harmonisation of monetary, fiscal and debt policies with a view to promoting stability in the financial system. The Committee is chaired by the Director-General of the Debt Management Office (DMO) or his representative who shall not be below the rank of a Director. The membership of the Committee comprises 16 Directors or their representatives drawn from 7 Ministries, Departments and Agencies (MDAs) namely DMO, CBN, Federal Ministry of Finance (FMF), Office of the Accountant-General of the Federation, Budget Office of the Federation, National Bureau of Statistics (NBS) and National Planning Commission (NPC). Among other things, the MFPCC is to harmonise the objectives of monetary policy, fiscal policy and debt policy towards achieving macroeconomic stability as well as to identify the activities and responsibilities required for meeting those objectives; ensure that the strategies for achieving fiscal, monetary and debt policies targets are properly synchronised so that they are complementary rather than conflicting; and eliminate distortions such as mismatches in the funding of the budget deficits and other government borrowings.

2.6 Sierra Leone

Monetary Policy

The ultimate policy objectives of the Bank of Sierra Leone (BSL) are price stability and sustained economic growth. Monetary policy framework of the Bank is a monetary–targeting regime with reserve money as the operational target and broad money supply as the intermediate target. The Bank conducts its monetary policy using open market operations to hit the reserve money before it affects the intermediate and ultimate targets (see Fig. 11 for trends in reserve money growth and inflation in Sierra Leone). The Monetary Policy Committee (MPC) formulates and directs the conduct of monetary policy in order to deliver price stability and support government objectives for sustainable growth; directs the conduct of the financial markets operation; reviews developments in the foreign exchange market and formulates policies to support macroeconomic stability; and addresses any other issues that have implications for the stability of the macro-economy.
Fig. 11

Sierra Leone—trends in reverse money growth and inflation, 1980–2011

Fiscal Policy

The thrust of fiscal policy in Sierra Leone is to formulate and implement sound economic policies and public financial management, ensure efficient allocation of public resources to promote stable economic growth (Fig. 12) and development in the context of a stable macroeconomic environment. Thus, fiscal policy framework is centred on sustaining spending on infrastructure development in order to spur sustainable economic growth; provision of basic services to make progress towards the attainment of the MDGs; improve domestic revenue collection; mobilizing concessional external support from traditional and non-traditional partners to finance critical infrastructure; and enhancing the capacity and productivity of the public service by implementing public sector reforms to ensure effective and efficient delivery of public services. The fiscal policy instruments are taxation and government expenditure and the key priorities are to increase fiscal space for developing basic infrastructure, improving social services, while supporting the effective participation of the private sector in the economy as well as implementing prudent expenditure management.
Fig. 12

Sierra Leone—trends in fiscal deficit and real GDP growth, 1980–2011

Policy Coordination

Policies have been harmonized by the institutional arrangements of both the fiscal and monetary authorities in Sierra Leone. However, the coordination process has not yet been formalised. There are committees that enable the BSL and the Ministry of Finance and Economic Development (MOFED) to be in regular contact, share information on policy issues and also jointly participate in the formulation and monitoring of policy implementation. These committees include the MPC, Monetary Policy Technical Committee (MPTC), and Cash Management Committee (CMC). The MPC comprises members from the BSL, MOFED and University of Sierra Leone. The Governor of the Bank chairs the Committee, which meets once every month. Since this committee includes senior officials from both authorities, policy recommendations and their implications on fiscal or monetary policy are discussed and addressed, and the outcome from such meetings are published in local newspapers. The MPTC is made up of the Directors of Financial Markets, Banking, Research and Banking Supervision from BSL; Director of Economic Policy and Research Unit, Director of Budget Bureau, The Accountant General and The Head of Public Debt Unit of MOFED; the Commissioner General of National Revenue Authority and the Statistician General of Statistics Sierra Leone. The MPTC is largely responsible for consolidating the inputs of the various departments on monetary policy related issues. It also reviews macroeconomic and monetary developments, both domestic and international and their likely impact on the BSL’s ability to achieve price stability. It further makes recommendations and advises the MPC on the stance of monetary policy. The CMC is chaired by the Financial Secretary, MOFED and comprises officials from the BSL, MOFED, National Revenue Authority (NRA) and Accountant general’s Office, and meets weekly. This Committee is largely responsible for the planning of financing requirements, deciding on the volume, timing, type and frequency of borrowing, among others.

3 Literature Review

3.1 Theoretical Literature Review

The literature on coordination has focused on two basic issues including: the fiscal theory of price level determination (FTPL) and strategic interaction. The FTPL states that the determination of inflation would no longer be a monetary phenomenon, but a fiscal one linked to the predetermined level of public debt. In the FTPL approach, the time paths of government debt, expenditure and taxes do not satisfy the inter-temporal solvency constraint, such that, in equilibrium, the price level has to adjust in order to ensure government solvency (see Semmler and Zhang 2003). In order words, the FTPL suggests the consolidated government present value budget constraint is an optimality condition, and it shows how Ricardian and non-Ricardian notions of wealth effects play a role in price determination and household consumption. A basic tenet of the FTPL is that monetary policy alone does not provide the nominal anchor for an economy. Instead, it is the pairing of a particular monetary policy with a particular fiscal policy that determines the path of the price level. A good coordination of monetary and fiscal policies is needed for price determination and control.

The second approach studies the interactions between monetary and fiscal policies from a strategic perspective in a game theoretic framework between the government and the central bank. Sargent and Wallace (1981) suggest that, if the central bank is independent from the fiscal authority and takes the lead in setting the path of inflation, then the fiscal authority, should select a sequence of primary surpluses (and debt) that is consistent with the order of money supplied by the monetary authority in terms of satisfying the government’s consolidated inter-temporal budget constraint. In such a situation, fiscal variables do not matter for price determination and, consequently, central banks committed to price stability can certainly deliver price stability regardless of fiscal policy. On the other hand, under a fiscal dominance regime, the fiscal authority will take the lead and move first by defining the path of the primary surplus/deficit. In such a situation, any adjustments by the authority to avoid explosive debt paths must come in the form of seigniorage revenues. Given the predetermined path for the primary surplus, tight monetary policy can potentially result in higher, instead of lower inflation. Standard monetary policy responses to inflationary shocks will have perverse effects: monetary tightening today prompts higher interest rates, increases interest payments on the government’s debt, and requires expansionary monetary policy in the future to generate additional seigniorage revenue. In this case, rational agents anticipate increase in money creation in future and bid the price level up today, a phenomenon referred to as unpleasant monetarist arithmetic (see Sargent and Wallace 1981).

According to Worrell (2000) the monetary and fiscal authorities should co-ordinate and agree on the size of the deficit and its financing mode. They should co-ordinate operating procedures, clarifying for themselves and the public who has the responsibility for debt management, cash management and liquidity forecasting as well as the one responsible for observing rules insulating the central bank from the government’s borrowing requirements. Generally, monetary and fiscal policy coordination is undertaken to (1) set internally consistent and mutually agreed targets of monetary and fiscal policies with a view to achieving non-inflationary stable growth; (2) facilitate effective implementation of policy decisions to achieve the set targets of monetary and fiscal policies efficiently through mutually supportive information sharing and purposeful discussions; and (3) compel both the central bank and government to adopt a sustainable policy. However, the reasons for coordination depend on the development of the financial markets. In the initial stages of financial market development, coordination is required to avoid excessive inflation rates. With further development of the financial market and some level of independence of the central bank, coordination is desirable to avoid high interest rates, which may harm economic growth. However, with full central bank independence and its ability to maintaining price stability, the main risk of failing to coordinate monetary and fiscal policies becomes the impact of high fiscal deficits on interest rates and economic growth.

In sum, without efficient policy coordination, financial instability could ensue, leading to high interest rates, exchange rate pressures, rapid inflation, and adverse impact on economic growth. A weak policy stance in one area burdens the other area and is unsustainable in the long run. Thus, the overarching objective of fiscal and monetary policy coordination will be to achieve stable and non-inflationary economic growth and thereby increasing the material welfare of the citizens (Arby and Hanif 2010).

3.2 Empirical Literature Review

Numerous empirical studies have examined the coordination between monetary and fiscal policies. For instance, Sargent and Wallace (1981) established that, a persistent budget deficit in a fiscally dominant regime will ultimately be financed through monetization, which will cause inflation in the economy. The study by Tabellini (1987) analyzes the coordination of monetary and fiscal policies in the context of a differential game modelled for a single country, where the target variable is the path of government debt across time. The study shows that policy coordination increases the speed of convergence to the steady state and leads the economy closer to the planned target as compared to the outcome of the non-cooperative game. Similarly, Lambertini and Rovelli (2002) also investigated the relationship between monetary and fiscal policy in the process of macroeconomic stabilization within a Stackelberg equilibrium framework. They identified three cases each assigning the initiative to treasury, government and central bank respectively in conduct of policy measures. The study concluded that the preferable and probable outcome is the one in which the fiscal authority appear as the leader in macroeconomic policy game.

Muscatelli et al. (2002) estimated VAR models with both constant and time varying parameters for G7 countries and found that monetary and fiscal policies were used as strategic complements. Their results indicate that the form of interdependence between fiscal and monetary policies was asymmetric across countries. Monetary policy was found to act in response to fiscal expansion in the US and the UK but no such evidence was found for France, Italy, and Germany. In another study, Nordhaus (1994), demonstrated that, under certain assumptions, government and monetary authorities in the US economy acting independently and non-cooperatively would produce an outcome, in which budget deficit and real interest rate would be higher than the wishes of the either authority. Melitz (1997) uses pooled data for 15 member states of the European Union (EU) to investigate the coordination between monetary and fiscal policies. The study revealed that coordinated macroeconomic policies are in practice in the region. Specifically, it concluded that “easy-fiscal” policy led to “tight-monetary” policy and “easy-monetary” policy, to “tight-fiscal” policy.

In an empirical investigation of a group of emerging market countries, Zoli and Lambert (2005) found that there was fiscal dominance in the case of Brazil and Argentina. They explained that fiscal policy actions appeared to have contributed to movements in the exchange rates more than unanticipated monetary policy manoeuvres, establishing the fact that fiscal policy did affect monetary variables. In the case of six South Asian countries, Hasan and Isgut (2009) using data for the period 1980–2008, found that fiscal policy responded to economic slowdown promptly, while the response of monetary policy was mixed.

Andlib et al. (2012) investigated the coordination of fiscal and monetary policy in Pakistan using unrestricted VAR model. The model consisted of four variables, two macroeconomic variables (output/unemployment and inflation) and two policy variables describing the monetary and fiscal policy stance. Using time series data from 1975 to 2011, they found that there was a weak coordination between monetary and fiscal authorities. Agha and Khan (2006) also concluded that inflation in Pakistan was a fiscal phenomenon, showing that fiscal policy significantly influences monetary policy conduct, and for better performance of the economy there needed to be policy coordination. In a related study, Nasir et al. (2010), using VAR model for the period 1975–2006 in Pakistan, also found weak co-ordination among the two policies. The study by Arby and Hanif (2010) also confirmed the weak policy coordination between the two policies in Pakistan, although they had been executed independently.

Despite the vast literature on monetary and fiscal policy coordination, empirical studies on the WAMZ economies are limited in coverage. The most recent study was done by Chuku (2012), using quarterly data to explore the monetary and fiscal policy interactions in Nigeria for the period 1970–2008. Using vector autoregression (VAR) and a State-space model with Markov-switching, the result indicated that monetary and fiscal policies in Nigeria had interacted in a counteractive manner, establishing the existence of weak coordination.

4 Theoretical Frame Work and Methodology

4.1 Policy Functions and Coordination

The basic instruments for delivering fiscal objectives are taxation and government spending. The outcomes of these tools culminate into fiscal balance (surplus or deficit). In the face of inadequate revenue mobilization, the government can embark on fiscal deficit creation for the realization of its spending outcomes. Thus, the overall government performance is summed up in the kind and level of fiscal balance. For monetary authorities, the choice of policy instruments depends on the level of financial development of the country. While the interest rate is the key policy variable in fully developed financial markets, the reserve money is the key operating target with broad money supply growth as intermediate target in less developed financial markets.

According to the Tinbergen’s rule, for the realization of policy goals, the number of policy instruments should be at least equal to the number of policy objectives. Going by this, it is clear that the two key macroeconomic policy objectives of price stability and full employment (reduction in unemployment) require at least two policy instruments for their realization (Tinbergen 1952, 1956; Theil 1964). For simplicity, one can consider the fiscal balance and the interest rate (reserve money) as the two key policy instruments that could be deployed to hit the policy targets. Where these instruments are in the hands of independent policymakers, the Tinbergen’s rule becomes only necessary but not sufficient for delivering on policy targets. Both the fiscal and monetary authorities are confronted with policy constraints which must be factored into their policy functions.

For the fiscal authorities, debt stability and sustainability become critical factors that enter into fiscal policy constraint. Overall, as far as fiscal policy target is concerned, inadequate fiscal space, large concentration of maturities at a point and contingent liabilities will limit government ability to roll over its debt (Hasan and Isgut 2009). The constraints facing the monetary authorities will emanate largely from fiscal dominance in a closed economy but also from exchange regime and administration in an open-economy setting. Thus, in addition to inadequate fiscal space, the level of short-term external inflows and possibility of their reversals will constrain the conduct of monetary policy.

Policy coordination becomes paramount when the two policy institutions are at least operationally independent of each other. Where the move of one institution depends on the actions of the other as in sequential-move games, coordination may be inherently assured (Arby and Hanif 2010) but this may be in opposite directions. For instance, in fiscal dominance regime, the fiscal authorities move first and define the path of primary surpluses/deficits. Monetary authorities’ response may be a tight monetary policy stance. The extent of fiscal dominance determines monetary policy effectiveness. One the other hand, monetary authorities can take the first move to determine the level of seigniorage revenue that can be raised by setting its policy prior to the fiscal policy. Fiscal authorities are then compelled to select a sequence of surpluses or debt that is consistent with money supply within the government’s consolidated inter-temporal budget constraint (Andlib et al. 2012). First mover advantage by the monetary authorities may impose discipline on fiscal authorities provided fiscal space is limited. However, in a coordinated simultaneous move games, the two independent institutions can engage in coordination that will see both policies move in the same direction as either expansionary fiscal and monetary policies or contractionary fiscal and monetary policies. These are essentially the results of explicit policy coordination. Empirically, it is not very easy and clear-cut testing for either implicit policy coordination as in sequential-move games or explicit policy coordination as in simultaneous-move games.

4.2 Theoretical Model Specification

The most commonly used utility functions for fiscal and monetary authorities in the literature (Andlib et al. 2012; Raj et al. 2011) are usually functions with three arguments namely unemployment, inflation and potential output growth. The difference between the utility functions of the two policy institutions stems from the fact that while the fiscal authorities assign more weight to unemployment than inflation, monetary authorities are biased towards inflation by assigning greater weight to it than unemployment. The utility functions are specified as follows:
$$ {U}^F= f\left(\overset{\frown }{\mu},\pi, \theta \right) $$
$$ {U}^M= f\left(\mu, \overset{\frown }{\pi},\theta \right) $$
where U F and U M are the utility functions of fiscal and monetary authorities, respectively; and μ, π & θ are unemployment rate, inflation rate and potential output growth, respectively. The hat on μ implies greater weight is assigned to unemployment and, in the same way, a hat on π implies greater weight is assigned to inflation. However, unemployment can be modelled as a function of interest rate and fiscal deficit (r, s). That is μ = f(r, s). Thus, Eqs. (1) and (2) can be restated as
$$ {U}^F= f\left( r, s,\pi, \overset{\frown }{\theta}\right) $$
$$ {U}^M= f\left( r, s,\overset{\frown }{\pi},\theta \right) $$
Equations (3) and (4) states that the utility functions of both fiscal and monetary authorities depend on policy instruments and policy targets. When policy instruments enter the utility function in place of unemployment rate, the fiscal authorities’ bias shifted to potential output growth, hence, the hat on θ in Eq. (3). While the fiscal authorities are to solve a growth maximisation problem subject to constraints emanating from monetary and external sectors of the economy, monetary authorities are faced with inflation minimisation problem with constraints from the fiscal and external sectors. The constraints of the two policy institutions can be formulated as reaction functions as follows:
$$ s= f\left( m,\theta, d\right) $$
$$ r= f\left( s,\pi, e,\varpi \right) $$
where m & d in Eq. (5) are defined as reserve money/GDP growth and public debt/GDP growth, respectively; and e & ϖ in Eq. (6) refer to exchange rate depreciation/appreciation and external reserves/GDP growth. In the fiscal policy reaction function, the reserve money/GDP growth is expected to capture seigniorage revenue that is generated from adjusting the monetary base, while public debt/GDP captures the fiscal space available to the fiscal authorities. On the other hand, exchange rate and external reserves changes are also issues of concerned to the monetary authorities especially in a managed-float regime, hence, they are factored into the monetary policy reaction function. In developing economies such as those in the West African Monetary Zone with relatively less developed financial systems, the interest rate (s) does not play a significant signalling role. Thus, the interest rate may be replaced by reserve money/GDP growth in Eqs. (3), (4) and (6).
Maximising the utility functions of the fiscal and monetary authorities with respect to potential output and inflation, respectively, and subject to the fiscal and monetary policy constraints (reaction functions) gives
$$ \theta = f\left( m, s,\pi, d,\lambda \right) $$
$$ \pi = f\left( m, s,\theta, e,\varpi, \lambda \right) $$

Equation (7) states that the equilibrium potential output growth in the economy is a function of base money supply growth, fiscal deficit, inflation and public debt. According to Eq. (8), the equilibrium inflation rate has its arguments as base money supply growth, fiscal deficit, potential output growth, exchange rate depreciation and external reserves. Lambda (λ) in both Eqs. (7) and (8) represents constraint coefficient which captures the marginal utility of adjusting policy instruments. It must also be noted that while adjustments in the arguments of Eq. (7) are expected to maximise potential output growth, those of Eq. (8) are expected to minimise the rate of inflation. Writing both equations as minimisation problems, Eq. (7) can be transformed by writing potential output growth as output gap. In this way, the problem reduces to how to choose growth of monetary base, fiscal deficit, inflation, government expenditure and public debt changes to minimise the output gap (that is, minimising fluctuations in output gap so as to keep output (GDP) close to its potential level).

4.3 Empirical Model Specification

In specifying the empirical model, attempt is made to first test for operational independence of the fiscal and monetary authorities. The question of coordination between monetary and fiscal policies arises only if the two institutions are independent, at least operationally.

This is done by conducting granger-causality test on indicators of fiscal and monetary policies, i.e. between fiscal deficit-GDP ratio and money supply-GDP ratio, and also explores the existence of co-integration between the two indicators. While the Granger causality test determines the impact of past information in one variable on the current value of the other, the cointegration test establishes if there is an equilibrium relationship between the two variables over the long run. The two institutions are considered independent if there is no cointegration and no pair-wise causality in the indicators of their respective policy stances. In this case, one has to find empirically if there is any existence of explicit policy coordination between the two policy institutions. Once the independence between the two institutions is observed, the next step is to determine the extent of coordination between them given different economic shocks. This study adopts two different approaches to finding out the existence of explicit policy coordination. The first approach is essentially a set theoretic approach based on the methodology adopted by Arby and Hanif (2010). The second approach makes use of a VAR framework following the works of Hasan and Isgut (2009) and Raj et al. (2011).

4.3.1 Set Theoretic Approach

The set theoretic approach of modelling explicit policy coordination makes use of a set theory. To ascertain the existence and effectiveness of explicit policy coordination, a macroeconomic environment matrix and policy response matrix are constructed with possible outcomes paired and compared in a set theoretic form. A policy target or macroeconomic environment matrix is constructed as follows:

In Table 1, the economic environment may present four possibilities of fiscal and monetary policy shocks. One possibility is a situation where shocks to both inflation and growth are positive, implying economic environment represented by (P, P); while another possibility is where negative shocks hit both inflation and growth giving rise to a policy environment (N, N). However, there may be conflicting shocks to inflation and growth, which will present either (P, N) or (N, P) policy environments.
Table 1

Macroeconomic environment matrix


Shocks to monetary policy target (inflation)

Positive (P)

Negative (N)

Shocks to fiscal policy target (growth)

Positive (P)

P, P

P, N

Negative (N)

N, P

N, N

It must be noted that cell (P, P) defines an overheating economy with increasing output growth and rising inflation, while cell (N, N) represents an economic trough or recession with rapidly declining output growth (or economic contraction) and decreasing inflation (or deflation). These two scenarios are normal cyclicality associated with the growth path of an economy. This growth cyclicality can be corrected by automatic stabilizers although may take time. However, cell (N, P) defines an unstable economic environment with low output growth and high inflation which necessarily requires active policy intervention to get to normality. Cell (P, N) also defines an unstable economy but more of expansion which may be ignited by bringing into the productive stream underutilized resources.

Thus, generally, policy inaction may be the best policy in this case. To avoid any ambiguity arising from benign policy environment requiring no serious policy intervention, the shocks that are identified in Table 1 should be those that cause output growth and inflation to deviate substantially from their long-run (steady state) path. Thus, the shock to growth (i.e. the output GAP) is a deviation of actual output from potential output, while shock to inflation is defined as a difference between observed inflation from threshold level of inflation for the WAMZ.

In the light of the foregoing representations, the responses of the fiscal and monetary authorities to the policy shocks are presented in Table 2.
Table 2

Policy response matrix

Policy direction

Monetary policy response

Contraction (C)

Expansion (E)

Fiscal policy response

Contraction (C)

C, C

C, E

Expansion (E)

E, C

E, E

The responses of fiscal and monetary policies to the shocks to the policy targets are depicted in Table 2. In reaction to the policy environment (P, P), the most likely policy responses will be contractionary fiscal and monetary policies as depicted by (C, C) in Table 2. Cell (E, E) will be the response pair to the policy environment cell (N, N). Similarly, cells (C, E) and (E, C) are the responses to the shocks in cells (P, N) and (N, P), respectively. It must be noted that the policy responses may come with a lag as policymakers first observe the impact of the shocks before taking action. Where policymakers fully anticipate the nature and likely impact of the shocks by taking remedial action well ahead, the impact of the shocks may be neutralized or reduced. Once the impact does not deviate substantially from the steady state path to warrant continued policy intervention, this situation may not be considered as requiring coordination.

Thus, the strength of coordination is defined as follows:
$$ sp{c}_t=\left\{ n\left({P}_{t-1}{P}_{t-1}\cap {C}_t{C}_t\right)+ n\left({P}_{t-1}{N}_{t-1}\cap {C}_t{E}_t\right)+ n\left({N}_{t-1}{P}_{t-1}\cap {E}_t{C}_t\right)+ n\left({N}_{t-1}{N}_{t-1}\cap {E}_t{E}_t\right)\right\}/ T\dots $$

Where spc ≡ strength of policy coordination, t ≡ time period and T ≡ total number of time series observations less one. If spc attains a value close to one (0.5 < spc < 1), policy coordination is considered strong, otherwise (0 < spc < 0.5), policy coordination is described as weak. Note, there would be perfect coordination if the four quadrants of macroeconomic environment matrix and policy response matrix are congruent (or equivalently spc =1 and no coordination if spc =0.

4.3.2 A Vector Autoregressive Technique

The strength of system-derived explicit policy coordination can also be ascertained using a vector autoregressive (VAR) approach. As noted by Hasan and Isgut (2009), a VAR model provides a simple means of explaining or predicting the values of a set of economic time series at a particular time period. Thus, it provides a powerful statistical forecasting tool for analysing historical data. The advantage of a VAR framework over structural modelling is that it avoids all structurally-induced restrictions or coefficient exclusions in order to get the model exactly or over-identified for a solution to be found. It also permits the capture of empirical regularities in the data using fewer key macroeconomic time series and, thereby, providing insight into channels through which the different policy variables operate in an economic system. Besides, the VAR framework provides a more convenient and comprehensive way of analyzing the impact of unanticipated shocks to the macroeconomic variables by way of impulse response function analysis.

The empirical VAR model is based on the variables identified in the theoretical framework above. The five-equation VAR model is specified as follows:
$$ GA{P}_t={\delta}_1+{\displaystyle \sum_{s=1}^p{\alpha}_{1 s} GA{P}_{t- s}}+{\displaystyle \sum_{s=1}^p{\beta}_{1 s} RM{G}_{t- s}}+{\displaystyle \sum_{s=1}^p{\lambda}_{1 s} FS{G}_{t- s}}+{\displaystyle \sum_{s=1}^p{\gamma}_{1 s} IN{F}_{t- s}}+{\displaystyle \sum_{s=1}^p{\phi}_{1 s} EX{R}_{t- s}}+{\varepsilon}_{1 t} $$
$$ RM{G}_t={\delta}_2+{\displaystyle \sum_{s=1}^p{\alpha}_{2 s} GA{P}_{t- s}}+{\displaystyle \sum_{s=1}^p{\beta}_{2 s} RM{G}_{t- s}}+{\displaystyle \sum_{s=1}^p{\lambda}_{2 s} FS{G}_{t- s}}+{\displaystyle \sum_{s=1}^p{\gamma}_{2 s} IN{F}_{t- s}}+{\displaystyle \sum_{s=1}^p{\phi}_{2 s} EX{R}_{t- s}}+{\varepsilon}_{2 t} $$
$$ FS{G}_t={\delta}_3+{\displaystyle \sum_{s=1}^p{\alpha}_{3 s} GA{P}_{t- s}}+{\displaystyle \sum_{s=1}^p{\beta}_{3 s} RM{G}_{t- s}}+{\displaystyle \sum_{s=1}^p{\lambda}_{3 s} FS{G}_{t- s}}+{\displaystyle \sum_{s=1}^p{\gamma}_{3 s} IN{F}_{t- s}}+{\displaystyle \sum_{s=1}^p{\phi}_{3 s} EX{R}_{t- s}}+{\varepsilon}_{3 t} $$
$$ IN{F}_t={\delta}_4+{\displaystyle \sum_{s=1}^p{\alpha}_{4 s} GA{P}_{t- s}}+{\displaystyle \sum_{s=1}^p{\beta}_{4 s} RM{G}_{t- s}}+{\displaystyle \sum_{s=1}^p{\lambda}_{4 s} FS{G}_{t- s}}+{\displaystyle \sum_{s=1}^p{\gamma}_{4 s} IN{F}_{t- s}}+{\displaystyle \sum_{s=1}^p{\phi}_{4 s} EX{R}_{t- s}}+{\varepsilon}_{4 t} $$
$$ EX{R}_t={\delta}_5+{\displaystyle \sum_{s=1}^p{\alpha}_{5 s} GA{P}_{t- s}}+{\displaystyle \sum_{s=1}^p{\beta}_{5 s} RM{G}_{t- s}}+{\displaystyle \sum_{s=1}^p{\lambda}_{5 s} FS{G}_{t- s}}+{\displaystyle \sum_{s=1}^p{\gamma}_{5 s} IN{F}_{t- s}}+{\displaystyle \sum_{s=1}^p{\phi}_{5 s} EX{R}_{t- s}+}{\varepsilon}_{5 t} $$

Where P is the optimal lag length and its value is determined using lag length test based on the following criteria: Sequential Modified Likelihood Ratio (LR), Final Prediction Error (FPE), Akaike Information Criterion (AIC), Schwarz Information Criterion (SC) and Hannan-Quinn Information Criterion (HQ). The impulse responses of RMG and FSG to inflation, exchange rate and output gap shocks are examined to see whether there is any system-derived explicit policy coordination.

4.4 Data Type and Sources

The key variables for the VAR model are changes in output gap (GAP) representing shock to output—measured as the difference between actual output and potential output, broad money/GDP (M2G), fiscal deficit/GDP (FSG), inflation (INF) and exchange rate depreciation (EXR). All the variables are either ratios or percentage changes. The study makes use of annual time series data for the period 1980–2011 for all countries. Data were obtained from United Nations and IMF eLibrary database. Output Gap was obtained by de-trending real GDP, using the Hodrick-prescott (H-P) filter from Eviews 7.0. The H-P filter is a method used to separate the cyclical component of a time series from raw data. Shocks to inflation and output gap are defined as deviations of these variables from their 3 years moving averages in either direction.

5 Presentation and Analysis of Empirical Results

5.1 Set Theoretic Model Results

The results of the set theoretic models indicate that explicit policy coordination in each of the WAMZ countries is weak (Table 3) as all the scores are less than 50.0 %. The policy prudence scores are also weak generally in all the countries except in Liberia, Nigeria and Sierra Leone where one policy institution has a policy prudence score above the threshold of 50.0 %. The Gambia obtains a coordination score of 10.3 %. That is, out of the 29 pairs of policy instruments and goals observed during the sample period, only 3 pairs suggest some form of policy coordination. Fiscal and monetary prudence scores for the Gambia are 48.3 and 34.5 %, respectively. This implies that fiscal authorities tend to implement relatively more prudent policies than does the central bank. Ghana achieves a coordination score of 34.5 %, implying only 10 pairs out of the 29 pairs of policy instruments and goals suggest coordination. The prudence scores are 44.8 and 48.3 % for the fiscal and monetary authorities, respectively, meaning that the BOG has undertaken relatively more prudent policies than their fiscal counterparts. Guinea has a coordination score of 19.0 %, meaning only 4 out of the 21 pairs of policy instruments and goals indicate some level of coordination. The policy prudence score of 47.6 % for each of the policy institutions in Guinea indicates that both fiscal and monetary policies were at par in terms of prudence.
Table 3

Strength of fiscal and monetary policy coordination in the WAMZ countries


Policy coordination score (%)

Fiscal prudence score (%)

Monetary prudence score (%)

The Gambia




















Sierra Leone




Source Authors’ computation

The policy coordination score for Liberia is 17.2 %, implying only 5 out of the 29 pairs of policy instruments and goals confirm coordination. Nigeria’s policy coordination score is 16.7 % which means only 5 out of the 29 pairs of policy instruments and goals observed indicate some level of coordination. Policy coordination score for Sierra Leone is 31.0 %, meaning only 9 out of the 29 pairs of policy instruments and goals observed reveal some coordination. Liberia and Sierra Leone have relatively weak fiscal prudence (41.0 and 48.3 %, respectively) but strong monetary prudence (51.7 and 65.5 %). Nigeria, on the other hand has a strong fiscal prudence with a score of 58.6 % but relatively weak monetary prudence (41.4 %). This may be explained by the fact that the periodic monetisation of oil revenue allocation to the various states in Nigeria tends to dampen the effectiveness of monetary policy, hence, lowering monetary policy prudence in the country.

5.2 VAR Model Results

Given that fiscal and monetary policy variables do not granger-cause each other (see Appendix 1), the study adopts the explicit policy coordination VAR model for estimation. The preliminary data tests such as stationarity and lag length criteria test results are presented in Appendices 2 and 3. The impulse responses based on the VAR results are generated using the generalised decomposition approach which is preferred to the Cholesky decomposition technique because it does not require that the model variables are specified in a particular order.

5.2.1 Results of the Panel Vector Autoregression

Response of FSG

From the panel VAR impulse response functions, fiscal deficit responds to its own shock by jumping down, implying worsening of the fiscal position in the first year following the shock. The response gradually wanes in an oscillatory manner until it dies out after tenth year of the forecast horizon. This suggests that within the WAMZ, fiscal authorities do react to fiscal shocks by widening the deficit in the years immediately following the shock. The response of fiscal deficit to money supply growth is to jump down, implying widening of the fiscal deficit in the first 2 years after the shock. The response then tapers off and dies out in the twelfth year of the forecast horizon. This means that fiscal position continues to deteriorate in the face of money supply shocks in the WAMZ. Thus, it appears fiscal policy does not support curtailment of excessive money supply growth in the WAMZ countries.

With regard to exchange rate depreciation shock, fiscal deficit jumps above the zero line, denoting a fiscal surplus following the depreciation. However, in the second year of the exchange rate shock, the WAMZ economies recorded a fiscal deficit, but the response peters out completely in the tenth year. The overall response to depreciation shocks is for fiscal deficit to worsen slightly and remain below its equilibrium level. It does appear therefore that fiscal deficit adjust to arrest any rapid rate of depreciation in the WAMZ countries (Fig. 13).
Fig. 13

Responses of fiscal deficit to selected macroeconomic shocks in the WAMZ

To an inflation shock, fiscal deficit jumps down, implying worsening deficit in the first year of the forecast period. The response dwindles and dies out in the fourteenth year. This suggests that fiscal policies are responsive but not supportive of price stability efforts in the WAMZ countries. To a one standard deviation shock in output gap, fiscal deficit jump above the zero line, thus recording a fiscal surplus in the first year of the shock. The response gradually decline and attain its equilibrium level after 10 years. This suggests that fiscal policy in the WAMZ countries tend to be implemented in a way to smooth the growth path.

In sum, fiscal policy appears to be self-corrective in the WAMZ countries as fiscal authorities take steps to improve the fiscal position in the years following an output shock. However, fiscal policy is found not supportive of price stability drive in the member countries as fiscal deficit continues to worsen even in the face of inflationary spikes.

Response of M2G

The response of money supply growth to fiscal deficit shock is to jump down in the year immediately following the shock. The response begins to wane during the second to tenth year of the forecast horizon. This implies that money supply shrinks in response to fiscal shocks in a form of widening fiscal deficit in the WAMZ countries. Money supply responds to its own shock by jumping up in the first year of the forecast period. It falls sharply in the second year before petering out gently afterwards until it dies out after the fifteenth year of the forecast horizon. This implies money supply continues to register high growth rates even after own shock in WAMZ member countries (Fig. 14).
Fig. 14

Responses of money supply growth to selected macroeconomic shocks in the WAMZ

Regarding exchange rate shocks, money supply growth does respond but only marginally positively from the first year to the eleventh year of the forecast horizon. This implies that money supply growth is not supportive of halting excessive exchange rate depreciation in the WAMZ countries.

Responding a one standard deviation inflationary shock, money supply growth jumps up in the first year and further increases in the second year of the forecast period. The response, thereafter, declines gradually until it dies out after 15 years. This indicates that adjustments in money supply are not supportive of halting inflationary spiral in the WAMZ countries.

With regard to output gap shock, money supply growth, in response, jumps down in the second year of the forecast horizon. The response peters out completely in the thirteenth year. Thus, monetary policies are supportive of smoothing the growth process in the WAMZ countries.

In summary, monetary policy is not accommodative and supportive of inflationary spikes and depreciation shocks in the WAMZ. This could be explained by the fact that inflation and exchange rates are more of structural phenomena than monetary phenomena. Hence, adjustments in money supply appeared to be ineffective in curtailing inflationary spiral and excessive depreciation of the local currencies in the WAMZ.

5.2.2 Results of the Country-Specific Vector Autoregressions

From individual country impulse response functions, country-specific responses of fiscal and monetary policies to macroeconomic shocks were observed. In The Gambia, fiscal operations tend to respond in a way to correct any excessive money supply growth and exchange rate depreciation. This means that fiscal policy adjustments in the face of monetary shocks appear to be supportive of monetary authorities’ desire to maintain price stability. On the other hand, monetary policy adjusts to neutralise shocks to fiscal variables but with a delayed effect. Money supply adjustments are also consistent with price stability objectives of the Central Bank of the Gambia.

In Ghana, Fiscal policy appears non-supportive of monetary policy as fiscal deficit continues to widen even in the face of rising money supply growth, while money supply growth continues to rise with deteriorating fiscal position, implying accommodating monetary policy. With regard to inflationary spikes and exchange rate depreciation, monetary policy does not respond adequately enough to counterbalance the shocks. Concerning output gap shocks, both fiscal and monetary policies do not respond significantly.

In Guinea, fiscal operations tend to respond in a way to correct any excessive money supply growth and exchange rate depreciation. However, monetary policy in Guinea appears not to be directed at addressing shocks to price and exchange rate, rather it appeared to be more reactive to fiscal policy dynamics and shock to output.

In the case of Liberia, fiscal policy adjustments do not help to contain inflationary spiral, exchange rate depreciation and money supply growth. Thus, although the response of fiscal deficit to various shocks wane out quickly, fiscal policy seems not to be implemented in a manner that delivers adequate interventions in the economy to forestall macroeconomic instabilities. On the other hand, money supply responds to inflationary and exchange rate shocks with a lag. However, money supply does not respond appropriately to shocks emanating from fiscal deficit and output.

In Nigeria, fiscal operations do not seem to contained inflationary spikes and halt depreciation of the domestic currency during the period under review. It does not adjust fully either in response to output gap shock. Thus, aside the long period taken for responses to die off, fiscal policy does not respond appropriately to macroeconomic shocks to the economy. On the other hand, money supply growth adjust appropriately to shocks emanating from inflation, output gap and fiscal variable, but does not respond adequately to address shock from exchange rate depreciation, during the period under review.

In the case of Sierra Leone, there is a delayed response from the fiscal authorities to exchange rate shocks, but responds appropriately to output gap shock, although it takes a longer time for the response to return to its equilibrium path. The response of fiscal policy to shock emanating from inflation remained inappropriate. Also, monetary policy appears to be supportive of exchange rate stability, but has a delayed response to shock emanating from inflation.

Overall, from both the panel and country-specific Vector Autoregresssions, policy coordination remained weak during the study period. Generally, these findings are consistent with those of Chuku (2012) that reveal weak coordination in Nigeria, Andlib et al. (2012), Aghan and Khan (2006), Nasir et al. (2010) and Arby and Hanif (2010), all of which point to weak policy coordination in Pakistan. The weak policy coordination in the WAMZ has contributed largely to the persistent non-compliance with inflation and fiscal deficit criteria by almost all Member States since the beginning of the WAMZ single currency project in 2001. Inflation and fiscal deficit criteria have remained the most challenging primary criteria to the WAMZ Member States.

6 Conclusion and Policy Recommendations

6.1 Summary of Findings

The study explores the existence of coordination between monetary and fiscal policies in the WAMZ in achieving the convergence criteria. Specifically, the study investigates the monetary and fiscal policy responses to shocks in key macroeconomic variables, including fiscal deficit, output, inflation, money growth and exchange rates. The set theoretic computation and the vector autoregressive (VAR) model were employed, using time series data for the period 1980–2011.

The paper establishes that monetary policy has been independent of the fiscal policy in all the WAMZ countries. Given the independence of the policies, the paper then works out the extent of coordination through movements of policy indicators. A major message from the study is that the achievement of macroeconomic policy goals requires a careful combination of fiscal and monetary policy instruments.

The results showed that all the WAMZ countries (both at individual and zonal level) had weak policy coordination during the study period. Results from the set theoretic coordination scores ranged from 10.3 % in The Gambia to 34.5 % in Ghana, clearly less than the 50.0 % benchmark for adequate policy coordination.

Results of the Impulse Response Function Analysis also showed that there are weak policy responses to shocks in model variables. The variables converge to their original values after a very long time, which shows that there is evidence of weak responses of policy variables to different shocks, reaffirming the weak coordination between monetary and fiscal policies.

6.2 Policy Recommendations

The policy coordination processes in most member countries have not been formalised. All member countries apart from Nigeria and The Gambia should put in place a formal coordination platform that will bring the two policy institutions together. In the case of Nigeria and The Gambia, there is a need to strengthen contacts between the monetary and fiscal authorities in deciding jointly on policy design and implementation.

Unless member countries are on IMF Programme, policy decisions emanating from coordination meetings are not followed through most of the time since they are not binding on the stakeholders. To solve this challenge, the authorities should endeavour to establish (or strengthen) set rules and procedures, which should be binding on both the fiscal and monetary authorities.

There is lack of adequate data to ensure effective coordination of fiscal and monetary policies in all member countries. To address this challenge, statistical bureaux/offices should be strengthened in terms of capacity and resource allocation to be able to produce quality high frequency data on their respective economies that will form the basis of policy coordination deliberations.

Closely linked with the above is the partial understanding of the workings of the macro-economy in most member countries. Thus, there is a need to strengthen the capacity of relevant policy institutions to be able to fully understand the cyclical nature of their respective economies in order to engage in effective policy coordination in the area of policy goal setting as well as choice and design of policy instruments. Policy transmission mechanisms also need to be identified and strengthened through relevant policy reforms in all member countries.

Policy institutions in member countries have weak or no monitoring and evaluation units that monitor policy implementation. Thus, authorities in member countries should establish monitoring and evaluation units in all relevant policy institutions to monitor policy implementation and track deliverables agreed on at policy coordination meetings.

7 Appendix 1: Granger Causality Test Results


FSG does not granger cause M2G

M2G does not granger cause FSG






























Sierra Leone





8 Appendix 2: Stationarity (ADF at Levels) Test Results







The Gambia























































Sierra Leone











*Figures italicised are probability values based on MacKinnon critical values

9 Appendix 3: Lag Length Test Results








The Gambia










7.91e + 09














7.44e + 10*







4.44e + 09*




Sierra Leone



1.30e + 11*




*Significant at 5% level


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Copyright information

© Springer International Publishing Switzerland 2014

Authors and Affiliations

  • Abwaku Englama
    • 1
  • Abu Bakarr Tarawalie
    • 1
  • Christian R. K. Ahortor
    • 2
  1. 1.West African Monetary InstituteGulf House, Tetteh Quarshie InterchangeAccraGhana
  2. 2.West African Monetary InstituteGulf House, Tetteh Quarshie InterchangeAccraGhana

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