Capital Flight and Monetary Policy in African Countries

"According to conventional economic theory, high interest rates are expected to stem capital flight by raising the relative rate of return to investment in domestic assets. However, African countries have experienced high capital flight over the past decades despite high interest rates and improved macroeconomic stability, implying that capital flight is not driven by arbitrage on the basis of the risk-adjusted rate of return to investment. Drawing on panel data covering 39 countries over 1970–2010, this study investigates the interactions between capital flight and monetary policy in Africa. The econometric analysis in this study finds no evidence of an impact of monetary policy instruments or targets on capital flight. Specifically, neither the domestic interest rate nor the interest rate differential with the rest of the world has an impact on capital flight. The evidence, however, shows that capital flight has a negative effect on monetary policy targets. It discourages domestic investment and retards the adjustment of output to its long-term growth rate. Two implications follow from the analysis. First, conventional policy prescriptions may not be effective for stemming capital flight from African countries. Second, capital flight may make monetary policy less effective in stimulating domestic demand and growth. This poses an important dilemma that calls for a serious rethinking of the monetary policy orientation in Africa."