Economic implications of external monetary policy shocks for Lesotho: An empirical investigation

Abstract

This paper investigates the responses of Lesotho’s economic growth and inflation to monetary policy shocks emanating from the USA. Among the countries that Lesotho’s economy is integrated into, the USA stands out as the key export destination claiming a substantial share of Lesotho’s textile and clothing exports, according to historical data. Using the structural vector autoregression analysis, the results show that Lesotho’s inflation temporarily increased following a shock to the USA monetary policy rate.  Moreover, Lesotho’s economic growth, measured by growth in the real gross domestic product (GDP), decreased over the horizon following a shock to the United States monetary policy rate. The effect on Lesotho’s economic growth can be attributed to declines in demand for Lesotho’s exports that have largely characterised periods of economic crises in the USA including the recent trade war between the USA and China, which according to the Central Bank of Lesotho, has been a major source of significant declines in Lesotho’s manufacturing production among other factors. Given that Lesotho is a small open economy operating under a fixed exchange rate regime where the Loti is pegged to the Rand, policy options available for Lesotho to mitigate external shocks could encompass the identification of additional buffers targeted at diverting the country’s capital to the most productive sectors other than clothing and textiles sub-sector. Policymakers in Lesotho could also exploit avenues to expand intra-regional trade with countries in both the Southern African Customs Union (SACU) and the Africa Continental Free Trade Area (AfCFTA).