While Botswana has had a good governance record, it has also had its fair share of challenges. This paper investigates why monetary policy in the country failed to contain inflation in the 2000s decade, and explores corresponding concerns over the fiscal cost of monetary sterilization, low monetary policy autonomy and real exchange rate appreciation. The findings provide an explanation for Botswana’s sub-optimal monetary policy outcomes that challenges the popular storyline. Accounting equations are used to estimate the net cost and sustainability of sterilization interventions and to compile a monetary policy autonomy index, while simultaneous equation estimation using two-stage least square regressions for a monetary policy reaction function and a capital flow equation provide measures of the extent of sterilization and of offsetting inflows prior to and after the great recession. The results show how a series of policy decisions from 1999 led (in the absence of appropriate countermeasures) to substantial loss of monetary policy autonomy, large offsetting inflows, unsustainable sterilization costs, high inflation and real exchange rate appreciation. In the wake of the great recession, excess liquidity pressures have now abated and offsetting inflows have tapered off, thus reducing the need for sterilization. Recent diamond import-linked (customs union) inward transfers to the current account have enabled reserve accumulation and recovery of monetary policy autonomy. However, these current conditions for enhancing monetary policy autonomy remain overly reliant on the diamond industry and may not be sustainable. A long-term solution is still needed as inflows from large trade surpluses may resume in the future.
