Openness and Monetary Policy in Small Developing Economies: Evidence from Sierra Leone

Abstract

As a post-conflict and fragile state, Sierra Leone has witnessed increased liberalization and greater openness since the end of the civil unrest in 2002. This high degree of openness appears to be negatively affecting the country’s balance of payments, with a substantial amount of foreign exchange earnings being spent annually the importation of essential commodities. Theoretically, openness may significantly contribute to weakening the effect of monetary policy on both output growth and exchange rate, but strengthens the effect on inflation. This study examines the implication of openness for the effectiveness of monetary policy in Sierra Leone. The autoregressive distributed lag technique was employed for quarterly data from the period 2002 to 2018. The results show that a higher degree of openness weakens the effect of monetary policy on both output growth and exchange rate, but strengthens the effect on inflation. The implication for policy is that, authorities should take into consideration the consequences of openness on the optimal monetary policy choice when taking monetary policy decisions.