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Last weekend, members of the Monetary Policy Department of the Central Bank of Nigeria (CBN) were in Lagos for the 2022 retreat with their eyes on evaluating the monetary framework and weighing the prospects of other models with regard to keeping the key economic prices in check.
Incidentally, the assessment came about a year into the ongoing aggressive monetary tightening that has raised the benchmarked interest rate by over 50 per cent – from 11.5 to 18 per cent – to keep inflation at a manageable level.
Sadly, within the period, the inflation rate jumped from less than 17 to over 22 per cent (the hottest in close to two decades), raising some questions about the effectiveness of targeting monetary aggregates as a route to pursuing the Bank’s price stability mandate. Perhaps, the inflation growth could have been much faster if the interest rate was left unchanged. But whether the monetary targeting (MT) framework, the backdrop of Nigeria’s monetary policy, produces the desired result or not and whether inflationary targeting (IT), a fast emerging model, is a sufficient replacement could be situated in a global context.
In the wake of bank failures (which were triggered by the declining mark-to-market value that led to capital erosion of some banks) and apprehension over the extreme hawkishness that has followed the cost of living crisis around the globe in the past two years, the ultra-low inflation targets of especially central banks of developed economies have come under intense scrutiny.
From America to Europe and from Canada to Australia, there is a groundswell of campaigns against randomly-selected low inflation targets that have invited probing into the origin of those numbers.
Whereas the Federal Reserve System, for instance, is fixated on bringing inflation down to the two per cent it set in 2012 at the risk of plunging the financial system into a deeper crisis and inducing recession, some economists have questioned the rationale behind the choice of two per cent as the inflation target. The hawks now have to defend that only two per cent inflation rate, indeed, and not three or four per cent equates, to price stability.
With the current inflation rate still above double what is considered healthy, some experts have called on the monetary authority to raise the target to say three per cent or extend the time horizon for meeting the mark to prevent the imminent negative consequence of over-tightening. The going interest rates have been raised from near zero to between five and 5.25 per cent in the past year. That has left foreboding of how more tightening could inflict serious damage on growth, employment and the already-shaky financial system.
There are sufficient reasons to be worried about the enforcement of extreme monetary licence. Some believe it has a plethora of market distortions, just like the elevated inflation it intends to control. It could create high-risk instruments or a bubble in which prices of assets spike to the rooftop when inflation is extremely low and central banks over-lose and investors go overboard regardless of the risks like the scenario witnessed during COVID-19 when cash hideouts were distributed to economic agents around the world without recourse to the level of goods supply. As seeds of financial instability are sold during low or negative inflation (deflation), when inflation returns – as seen in the past two years – financial crises erupt with ultra-high interest rates.
The recent collapse of SVB and some cryptocurrency exchanges, which could not survive the ripple effects of high-interest rates and asset repricing, are an example of how the financial system could respond to a restrictive credit environment and drives home the arguments of those seeking an adjustment to extremely-low inflation target numbers.
Equilibriums, whether of price or any other variables, are not static in the long run. From that standpoint, the case of more flexible inflation targets is anchored on the possibility of upward movement of the global price equilibrium level.
Yet, even economists that have differed from the rigid path to achieving price stability in the America and elsewhere have not thrown away the merits of IT, a monetary policy approach first adopted by New Zealand in 1989, alongside the randomly-picked inflation goalposts.
IT has gained traction among monetary policy managers in recent years owing to its ability to tame inflationary expectations (which is equal to actual inflation in theory) more firmly than monetary targeting, exchange rate targeting, interest rate targeting, nominal output targeting and other approaches, especially when implemented transparently. The model is also perceived to resonate better with economies that tend towards openness and confidence building. This is because monetary authorities communicate clearly their inflation targets and set explicit targets for self-evaluation and public assessment.
In practice, a monetary authority models the path to future inflation targets and adapts to the level of monetary tightening (adjusting monetary policy rate, liquidity ratio, open market operation, cash reserve ratio) to achieve its goal.
To achieve their core mandate of non-inflationary growth, monetary policy managers could control the money supply or inflation base with the expectation that when one is achieved, there would be a knock-on effect on the other in a sort of pull or push manner. But with globalisation, innovation and liberalisation, anchoring inflation on the money supply level is increasingly becoming challenging, thus making money supply control a weak or unrealistic determiner of price stability.
Little wonder, IT has gained popularity since the New Zealand experiment. Ghana, Kenya, South Africa and a few other African countries have jumped on the bandwagon, while Nigeria continues with MT, a product of a long history of experimentation on what serves the country’s peculiarities best. Nigeria had experimented with exchange rate targeting, a hybrid of different frameworks and what the Director of the Monetary Policy Department, Dr. Hassan Mahmud, described as “implicit IT” before migrating fully to MT.
Today, the efficiency of the MT framework, which seeks to hold monetary aggregates at a constant or pre-determined volume while adjusting monetary policy to achieve the target, is being interrogated, not by its many critics, but by the CBN itself.
At the last weekend retreat, Mahmud, said: “the effectiveness of monetary targeting in achieving price stability in Nigeria has been called into question”.
“One of the main challenges has been the difficulty of accurately measuring and controlling the money supply in the face of financial innovation and the growth of non-bank financial institutions. In addition, the relationship between the money supply and inflation has become less predictable in recent years, further complicating the use of monetary targeting as a policy tool,” he added.
The monetary policy expert did highlight some of the perceived benefits of MT such as providing a clear anchor for monetary policy and ease of adjustment of its operations to measure and control the money supply level.
Its relevance, however, depends on the accuracy of monetary aggregates as a measure of inflationary pressures and the ability of monetary policy to influence the behaviour of economic agents, he said. With the huge underground economy, slow pace of formalisation of the informal sector and long history of unabated fiscal rascality, the CBN must have admitted the severity of the constraints of MT.
“Ultimately, the central bank will need to interrogate the continued relevance of the MT framework to address the series of new and developing shocks impacting the Nigerian economy as well as the advantages the IT framework may hold for us as a central bank,” Mahmud told his colleagues.
On the possible transition to a new framework, Hassan told the media that the CBN was at the point of testing all relevant scenarios and modeling all possibilities in the light of the economic realities before coming up with its inflation targets. He was, however, not certain if the authority would opt for single-digit inflation or something a low double-digit.
The last time the country achieved a single-digital inflation rate was in January 2016. The inflation of last month is due today, which could come hotter than last month when the composite consumer price index (CPI) printed 22.04 per cent, the highest in close to 20 years.
There have been concerns about the Central Bank’s limited hold on inflation and the effectiveness of control measures that isolate the fiscal authority. With most factories compelled to explore alternative energy to power their operations and diesel prices increased by about fourfold since last year, local manufacturing is not seen as an attractive enterprise to the majority of investors. Besides, there are other several supply-side challenges including insecurity, multiple taxation, smuggling, poor road networks and skill gap to grapple with.
But Mahmud insisted that inflation has, starting from post-COVID-19 money supply growth, become more of a monetary phenomenon – a reason central banks are paying closer attention to inflation control across the globe. According to him, the CBN will assess its tools to determine if it could effectively implement IT as its major monetary framework going forward.
“You would understand that we have not had an efficient monetary policy. As you mop up, you still find that the economy is awash perhaps from currency outside the banking system that impacts the prices. That makes monetary policy less efficient or the outcome less optimal. The point is: are we at a stage can start focusing on our core mandate, which is price stability using inflation as a target instead of monetary aggregate?
“That would mean looking at inflation explicitly by coming up with an inflation target of maybe eight to 10 per cent or 10 to 12 per cent, depending on the result of our modeling. We will announce that to the public so that members of the public would then begin to assess the CBN based on how it can stay within its target. We will be looking at the inflation number and using other parameters to achieve the targets,” Mahmud told the media.
While setting time for deliberation at the retreat themed, ‘Monetary Targeting Policy Framework in Nigeria – An Appraisal of its Continued Relevance to the Price Stability Mandate’, the Deputy Governor (Economic Policy), Dr. Kingsley Obiora, narrated how domestic economic realities, market shocks and external exigencies had influenced CBN’s choices and changes of monetary frameworks – from exchange rate targeting to the most recent MT.
“In today’s economy, rapid technological advancements and increasing competition are changing not only the way we do business but also the definition of money. The rapidly changing macroeconomic environment has meant that the continued reliance on money supply growth as a reliable guide to the trend of price development has become questionable, not just among central bankers but also among academics. In addition, the relationship between money supply growth and the money multiplier has become increasingly blurred due to the observed instability in the money multiplier, making it difficult to set appropriate targets for money supply growth,” Obiora argued.
He said the Bank was compelled to examine the pros and cons of a transition to a more relevant framework “to improve our ability to continue to anchor inflation expectations” and achieve price stability.
Perhaps, a former American President, Gerald Ford, captured the enormity of price instability most succinctly when he described a double-digit as “public enemy number one”. A few years after Ford’s iconic allusion, President Ronald Reagan labelled it the “cruelest tax”.
Nigeria is currently paying that “cruelest tax” as a result of an interplay of factors ranging from monetary policy failure to structural factors, including insecurity and poor fiscal incentives. Many countries ditched money supply control to set narrow goalposts for inflation, which is considered to have a more direct impact on other prices such as exchange and interest rates.
Perhaps, it is time Nigeria jumped on the bandwagon for improved and faster monetary policy transmission, even if it means being less rigid than it has been applied in the United States and other developed economies.
