Domestic Debt and Monetary Policy Transmission in The Gambia

Abstract

The increase in domestic government debt has heightened the fear of fiscal-monetary interactions in the developing economies, especially the small open economies that have shallow financial markets. Although much focus has been given to the sustainability of external debt, short-term monetary transmission impacts of domestic public debt have not been well studied in the low-income countries. This paper examines the short-term macroeconomic impact of domestic public debt on the vital monetary policy indicators in the Gambia between the years 1983 and 2022. The analysis can determine the effects of domestic borrowing on money supply, interest rates, inflation and exchange rate fluctuations using annual time-series data and an Autoregressive Distributed Lag (ARDL) framework suitable to study integrated processes and small samples. The unit root and cointegration tests have ensured that there is a stable relationship of the long run between the variables, whereas short run ARDL estimates have shown that there are statistically significant fiscal-monetary transmission effects. The findings show that an increase in domestic public debt increases the money supply, raises interest rates, creates inflationary pressures and also leads to currency depreciation in the short term. The results obtained support empirically fiscal dominance and crowding-out processes in financially constrained economies. The work is novel in the literature by presenting one of the longest four-decade time-series studies of domestic debt-monetary interactions in The Gambia and to the wider body of knowledge on fiscal-monetary interactions in Sub-Saharan Africa. The results highlight the need to have prudent domestic debt management, strengthened fiscal discipline, and improved fiscal-monetary coordination to protect the macroeconomic stability.

Keywords: Domestic Public Debt; Monetary Policy Transmission; ARDL; Fiscal Dominance; Inflation; Exchange Rate; The Gambia