Understanding the Dynamics Between Monetary Policy and Interest Rate Spreads in Uganda: A Quantitative Study

Abstract

This study delves into the intricate relationship between monetary policy variables and interest rate spreads in Uganda's financial sector. It examines the impact of the rediscount rate, inflation, money supply, and the Real Effective Exchange Rate on interest rate spreads. Findings indicate that while short-term changes in the rediscount rate have a limited effect on interest rate spreads, higher rates widen spreads in the long term as banks adjust strategically. Initially, inflation narrows spreads, but persistent high inflation widens them over time as banks hedge against inflation risk. Moreover, an increase in money supply reduces spreads in the short run but has diminishing effects over time. Recommendations include transparent adjustments of the rediscount rate, robust inflation targeting frameworks, and vigilant monitoring of the money supply to support economic growth and financial stability. Overall, this study provides insights for policymakers and financial institutions, emphasizing the importance of considering both short-term and long-term effects in monetary policy adjustments for Uganda's economic stability.