Effects of Monetary Policy on Bank’s Credit Dynamics in Tanzania

Abstract

In a similar trend to other East African Community partner states, growth of credit to private sector in Tanzania has been declining in the recent past, despite massive effort by the monetary policy to boost bank’s credit extension. Using quarterly data spanning from 2002 to 2019, this paper estimates a structural vector autoregressive model to examine the intertwined relationships between monetary policy and growth of private sector credit, together with other key macroeconomic variables in Tanzania. Estimates from the model shows that the real effect of monetary policy on credit growth is quantitatively small — a 2.5% rise in cash rate leads to a decline in real growth of credit to the private sector by 0.1%. Though, in responding to the macroeconomic consequences of the shock in growth of private sector credit, monetary policy appears to stabilise the economy effectively. At short horizons, shocks to monetary policy found to be a significant driver of credit growth. Over longer horizons, shocks to real output, past shocks to credit growth and external shocks plays a greater role. The contemporaneous effects of external shocks to the growth of private sector credit takes slightly more than two years to disappears, but it would have taken much longer in the absence of a monetary policy response. These findings assert that, bank’s capacity to credit extension is vulnerable to both domestic and external shocks, and although it may be unfeasible for the monetary policy to fully caution the banking system from shocks, a quick and appropriate policy response may help banks to quickly recover from unexpected shocks.