Monetary Policy as Gamble?

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Obinna Chima wonders if an accommodating monetary policy regime, as advocated by some analysts would be effective in an economy that is under recession

In a recent address to members of the Nigerian Bar Association (NBA), at their 2017 Annual General Conference in Lagos, the Central Bank of Nigeria (CBN) Governor, Mr. Godwin Emefiele stressed that monetary policy alone cannot deliver everything in an economy.

He confessed that the CBN’s monetary policy has its limitations when dealing with the challenges that confront a nation during recession. According to him, one of the major lessons learnt from the global financial crises of 2008-2009 was the need to develop an adequate framework and appropriate tools for managing financial stability, particularly macro-prudential and micro-prudential policies and crisis management continuum.

Emefiele pointed out that a casual look at the problems that hit the economy two to three years ago, “even for the untrained eye, will reveal that these are daunting challenges in their individual rights”.

Emefiele is not alone in suggesting that too much was being expected of central bankers in promoting growth and reducing unemployment.

Similar sentiment came from the Chair of former president Barack Obama’s Global Development Council, Mohamed El-Erian, who in his book titled: “The Only Game in Town,” highlighted the challenges that confront central banks globally.
El-Erian noted that central banks had been considered the only game in town and wondered whether the very high expectations placed on them might backfire in the future.

According to him, ever since the 2008 global financial crisis, central banks had ventured, not by choice, but by necessity, ever deeper into unfamiliar and tricky terrain of unfamiliar unconventional monetary policies as well as heavily intervened in the functioning of markets. He also revealed that during the 2008 financial crisis, in the US, “a myriad of emergency funding windows were opened to enable cash to be injected into the financial system, and from virtually any and all directions.”

Indeed, central banks globally are confronted with varying degree of challenges.
In Nigeria, faced with the challenge of the slump in crude oil prices in 2014, which thereafter snowballed into a foreign exchange crisis, the Central Bank of Nigeria (CBN) had to continuously adjust its policies to achieve the desired results. In addition, the delay by President Muhammadu Buhari in forming his cabinet months after he was inaugurated in 2015 then put the responsibility of managing the economy on the shoulders of the central bank.

Since last year, policy makers have been battling to lift the economy out of a biting economic recession. Nigeria’s first quarter 2017 Gross Domestic Product (GDP) showed that the economy contracted by 0.52 per cent (year-on-year) in real terms, indicating five consecutive quarters of contractions since the Q1 2016. This was however 0.15 per cent higher than the rate recorded in the corresponding quarter of 2016 (revised to –0.67 per cent from –0.36 per cent) and higher by 1.21 percentage points from the rate recorded in the preceding quarter (revised to –1.73 per cent from –1.30 per cent)
There are predictions that the decelerating inflation and negative GDP growth, as well as increased capacity utilisation and agriculture output are all signs that the economy was on the path to recovery.

Dilemma of Monetary Policy
Emefiele noted that the real dilemma that confronts central bankers was that the issue of trade-off in the outcomes of economic variables.

“For example, one would expect that given the Bank’s core mandate to pursue low inflation, the central bank would implement policies geared towards that.

“In order to tackle high inflation, the correct monetary policy would be to tighten money supply either by increasing the Cash Reserve Requirement (CRR) of banks, mopping up money through increased open market operations, or raising the liquidity ratio of banks.

“Doing any or a combination of these would help to moderate inflationary. Yet, if a central bank in our position were to abandon its pursuit of low inflation and decide to implement an expansionary monetary policy in order to engender rapid economic growth, the outcome for inflation would be much worse.

“This is because an expansionary monetary policy would require reducing the CRR and liquidity ratios and increasing money supply. Obviously, with much more money in circulation, inflation would be worse.

“In view of the dilemma of tackling these problems simultaneously, the optimal solution would be to prioritise and address them sequentially.

“Given our core mandate, and the pervasive effect of high inflation and exchange rate volatility, we chose to tackle these two head-on. It is important to highlight that high inflation is a significant inhibitor of economic growth,” he explained.
According to the CBN governor, high inflation was not only harmful to growth in the long run, but discourages saving and inhibits planning and investment, as people become more sceptical over the direction of prices of goods and services.

As a result, achieving low inflation, he said, remains a major priority for the CBN, saying that if the central bank had chosen to reduce interest rates and increase money supply under the circumstances, it would have further deepened the recession while foreign investment outflows would have worsened foreign exchange reserves accretion.

Emefiele said in order to contain the challenges, the CBN took a number of countervailing policy actions both at the management level and at its MPC, such as to maintain a tight monetary stance in order to contain rising inflation and encourage FX inflows into the country.

“More importantly, however, in order to further extricate the lingering bottlenecks, increase transparency and boost supply in the FX market the CBN, in April 2017, introduced the special Investors’ and Exporters’ (I&E) FX window. The establishment of that special (I&E) window has tremendously facilitated market-driven transactions,” he added.

Limitations
The Director General of the West African Institute for Financial and Economic Management, Prof. Akpan Ekpo, aligned with Emefiele, saying the effectiveness of monetary policy tools during an economic recession is limited.
“Right now, we are in a recession and monetary policy cannot do anything. What we need now is more of a fiscal stimulus and there should be no delay in policy implementation. We need structural reforms now.”

However, Ekpo advised that once the economy comes out of recession, the central bank should concentrate on using monetary policy to enhance growth instead of fighting inflation.

To analysts at Lagos-based CSL Stockbrokers Limited, attempt to loosen monetary policy during a recession, may affect attempts to stimulate the economy.

“Moreover, a rate cut aimed at stimulating demand could make things worse for the economy, as it would likely lead to a widening current account deficit, worsen inflation, exacerbate foreign exchange shortages and push real interest rates deeper into negative territory,” they added.

Also, analysts at Ecobank Nigeria Limited urged the CBN to sustain and deepen its foreign exchange management policies.
But the Director General, Lagos Chamber of Commerce and Industry (LCCI), Mr. Muda Yusuf said: “We would like to see a better interest rate regime. We feel the current interest rate is too high for businesses. But the position of the CBN is that relaxing its tight monetary policy would pose a risk to inflation.

“But our view is that under the prevailing interest rate regime, businesses would find it very difficult to succeed.
“But the good thing is that we have seen some improvement in foreign exchange policy regime, which is a consolation for us. So, gradually, we hope they would get to a point where they begin to relax the monetary policy condition.”

Analyst for FXTM, Lukman Otunuga noted that with Nigeria’s GDP for the first quarter of 2017 still in recessionary territory, the damage of depreciating oil prices still lingers on with social economic issues.

The foregoing therefore shows the need for increased collaboration between the fiscal and monetary policy authorities in order to do everything possible to steer the economy onto the road of positive economic growth and unleash the country’s untapped potential.