The Central Bank of Egypt has announced its intention to move to an inflation targeting framework
when its prerequisites are satisfied. This raises an important question regarding the rationality of
shifting to inflation targeting instead of monetary aggregate targeting currently applied. Thus, if
the monetary authorities can achieve monetary stability using its current monetary policy, it should
continue target monetary aggregates. A successful monetary aggregate targeting regime hinges on
two pillars: (1) the stability of the relationship between that targeted monetary aggregate and
nominal GDP which implies a stable velocity of circulation. (2) The monetary aggregate must be
under the control of the central bank which requires the stability or predictability of money
multiplier. Therefore, the paper aims at examining the stochastic structure of both money multiplier
and velocity of M1 and M2 using Variance Ratio tests of LO and MacKinlay (1988) and (1989),
Chow and Denning (1993) and wild bootstrap of Kim (2006).
The paper used a sample of quarterly data for the period (1991:1-2009:2) for velocity
variables and the period (2001:4-2009:2) for the money multiplier. The results indicate that the
three variables follow random walk process. Therefore, they are unpredictable random sequences.
With respect to money multiplier, this means that the linkage between money supply and money
base is broken. Therefore, the Central bank of Egypt cannot achieve its main goal of low inflation
as the money supply would be outside its control. Concerning velocity of circulation, as it provides
the linkage between the monetary aggregate and GDP, the monetary authorities would not be able
to achieve the required nominal GDP target since the velocity of money is instable. Based on that,
the goals of low inflation and promoting output growth cannot be attained under the current policy
framework and central bank should take further steps towards the full-fledged inflation targeting
regime. |
