Nominal versus Real Deposit Dollarization in Zambia: Determinants and Monetary Policy Insights

Abstract

This study investigates the determinants of deposit dollarization in Zambia after transition of monetary policy to inflation targeting and introduction of a Monetary Policy Rate (MPR). Using quarterly data from 2012 to 2023, two indices of dollarization are constructed — nominal and real (adjusted for exchange rate fluctuations). We find that while nominal dollarization has remained elevated, real dollarization has trended downward over time. Empirical estimates from an autoregressive distributed lag (ARDL) model indicate that nominal dollarization is largely driven by money supply, output, and the exchange rate, whereas real dollarization is determined primarily by output and exchange rate volatility. The MPR exerts a modest but statistically significant effect on nominal dollarization. Impulse responses obtained using local projection framework show that MPR hikes yield short-term reductions in nominal dollarization, whereas exchange
rate innovations have a more pronounced and sustained influence over both indices time. These findings underscore the need for coordinated monetary and exchange rate stabilization policies to effectively manage dollarization pressures in developing economies with multiple currencies in
circulation.