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High interest rates prevail in developing countries including Tanzania since full
implementation of financial sector reforms where interest determined by the market
force have restricted the access of potential borrowers to credit markets thus reducing
investments and limiting growth potentials of the economy. This study was conducted
to determine the dynamic determinants of interest rates in Tanzania with a focus on
inflation, money supply and exchange rates. The study used time series secondary data
covering the period 1970-2013, extracted from two main sources, namely; the National
Bureau of Statistics (NBS) and Central Bank of Tanzania (BoT), where all variables
employed on the analysis are extracted. The study applied OLS, Johnsen Cointegration
and VECM technique to examine the effect of Inflation Rates, Money Supply and
Exchange Rates Dynamics to Interest Rates in Tanzania. Johnsen co-integration test
was employed to test for existence of long run relationships between variables interest
rate, inflation rate, money supply and exchange rates and the results showed the
existence of long run relationship among variables and they move together and
suggested to use VECM instead of VAR. Stationarity test was enhanced by the use of
Augmented Dickey Fuller and Philip Perron test. The results showed that all variables
exhibit unit roots at level and they became stationary after performing first difference.
VECM results revealed that money supply had significant effect on interest rate and
the effect of inflation rate and exchange rate dynamics to interest rate were not
significant for the period under study. Therefore, in order to correct short term
disequilibrium of interest rate, the government should adjust money supply. The OLS
results showed that explanatory variables significantly affect interest rates but the Rsquare
was very low for the model. Even if, only money supply seemed to have
statistically significant impact on interest rate, the government should not ignore other
variables such inflation rate and exchange rate because they are important in monetary
policy setting.
Keywords: Interest rate, Inflation rate, Money Supply, Exchange rates, Tanzania. |
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