The Bank of Tanzania implements quantity based monetary policy framework. Under this framework, the Bank targets reserve money (operating target) growth rate thereby influencing the amount of money supply (M3- Intermediate target) growth consistent with monetary policy objectives.
Operating Target
An operating variable/target is a variable that can easily be controlled by the central bank. However, the actual choice of target depends on factors such as the level of sophistication of markets, or the type of anchor being used by the central bank (i.e. money based vs. exchange rate based stabilization or interest based). Generally, the chosen target must be measurable, controllable and predictable. The Bank of Tanzania uses reserve (base/ high powered) money as the operating variable/target.
Intermediate Target
An intermediate target is a quantifiable target, strongly influenced by the operating target and closely linked to the ultimate/monetary policy primary objective(price stability). This may be either the money supply or exchange rate level, depending on the type of anchor being used by the central bank. The Bank of Tanzania uses the extended broad money supply (M3) as the intermediate target.
To achieve the Monetary Policy primary objective and the above mentioned targets, Bank of Tanzania employs various Monetary policy instruments namely, open market operations (OMO), reserve requirements, discount policy, foreign exchange market operations, repurchase agreements, moral suasion and gentlemen’s agreements. These instruments affect the supply of money through changing either the stock of reserve money or the money multiplier.
Open Market Operations
Two main approaches are used in OMO: the active approach and the passive approach. The active approach aims at attaining a particular level of base money, while allowing the price of reserves (i.e. interest rates) to fluctuate freely. This approach is generally good for economies which lack efficient secondary or inter-bank markets, for it allows the central bank to define its goal more clearly, especially when control of inflation is the overriding goal. By contrast, the passive approach aims at a particular price of reserves (interest rate) while allowing the amount of reserves to fluctuate. This system is better suited to well-developed and sensitive markets. The Bank of Tanzania is using OMO as the principal instrument for monetary policy.Foreign Exchange Market Operations
Foreign exchange market operations are conducted through the Inter-bank Foreign Exchange Market, where the central bank buys and sells foreign exchange to commercial banks. However, the exchange rate of the shilling is freely determined by the market, with the central bank intervening only to smoothen short fluctuations and build external reserves, without prejudice to the primary objective of price stability.Reserve requirements
For people to have faith in a currency, the value and stability of that currency must be backed up, and this is done with the reserves of the central banks. Currency reserves have a key role in maintaining confidence in the economy and in supporting the stability of the financial system. Central banks traditionally used reserve requirements as an instrument for monetary control. These requirements work by affecting the proportion of assets that banks are required to hold, and hence their ability to expand liquidity.Discount rate
The discount rate is the rate that the central bank charges on funds borrowed from it by commercial banks and the government. When there is a tight monetary policy stance, the discount rate imposes limitations on access by banks and government to borrowing from the central bank. Since the Bank of Tanzania uses OMO as the principal tool for monetary policy implementation, the discount rate is highly restrictive so as to discourage borrowers from resorting to the discount window. A 5 percentage penal rate is currently used above the weighted average yield for all Treasury bill maturities.Moral Suasion
Attempts by the central bank to influence the behavior of market players are normally described as moral suasion. The Bank of Tanzania, especially in persuading commercial banks to be prudent in setting their deposit and lending rates, sometimes applies this instrument. However, moral suasion is always used in conjunction with other instruments.Gentleman's Agreements
These are voluntary agreements between the Bank of Tanzania and banks, aimed at improving monetary conditions in the economy. Such agreements have been used between the central bank and the largest commercial bank in an effort to lower the spread on interest rates.