Rethinking monetary policy in times of recession
In line with its core mandate as enshrined in the CBN Act (2007), the maintenance of monetary and price stability has remained the main focus of monetary policy since 2011 following the restoration of stability in the banking system after the global financial crises.
This explains the tight monetary policy stance adopted by the Central Bank of Nigeria (CBN) over the period using the Monetary Policy Rate (MPR) as the principal instrument to control the direction of interest rates and anchor inflation expectations in the economy.
The other intervention instruments included Open Market Operations (OMO), Discount Window Operations, Cash Reserve Ratio (CRR) and foreign exchange Net Open Position (NOP). Headline inflation moderated for most part of the period in response to the policy measures implemented by the CBN.
It only surpassed the CBN upper band limit of 9 percent adopted by the apex Bank in 2013 when it spiked to 9.2 per cent in June 2015. So, inflation targeting worked well not least because Gross Domestic Product (GDP) remained positive. The single digit headline inflation rate sustained till the end of 2015 is evidence of the effectiveness of monetary policy during the period.
However, both history and logic point to the dangers of adopting inflation targeting in periods of negative growth in output as doing so often leads to worse outcomes for the real economy.
In the 1970’s for instance, there was increased concern particularly in industrialized countries about the level of employment and central bankers felt the need to stimulate employment by loosening monetary constraints even at the risk of inflationary spiral. By the same token, the Bank of England in 2008 had to cut interest rates drastically and tolerate cost-push inflation of 5 per cent in recognition of the weakness of tightening monetary policy during a period of recession.
In August 2016, it equally saw reason to cut the benchmark rate from 0.5 per cent to 0.25 per cent as a proactive measure to avert a possible recession from Brexit even when its inflation target was 2 per cent- well above the policy rate.
Today, there are no overstating Nigeria’s economic woes. Oil revenue, the chief source of the country’s forex receipts, has taken a serious plunge dragging down growth in its wake. Economic growth over first two quarters of 2016, measured by real (GDP) has been negative. The number of jobs has significantly declined and yet inflation pressures continue to build up. The latest report by the National Bureau of Statistics (NBS) on GDP performance officially confirmed that the country is in a recession contracting for two consecutive quarters by 0.36 per cent and 2.06 per cent in Q1 and Q2 respectively with unemployment rate as high as 13.3 per cent.
So unlike the previous years, the monetary policy environment this year has been characterized not only by the threat of inflationary pressure but also by a greater risk of economic recession and rising unemployment. Yet, the Monetary Policy Committee (MPC) did not deem it wise to ‘change dancing steps in tune with the changing beats’ by reviewing the thrust of monetary policy in the light of the downturn in economic activities. For example, in apparent reliance on the ‘Taylor rule’ which requires that for monetary policy to stabilize prices, the nominal interest rate must be raised by more than the level of inflation, it jerked up in March this year the MPR from 11 per cent to 12 per cent as well as the CRR from 20 per cent to 22.5 per cent in response to the uptick in headline inflation from 9.6 per cent in January to 11.4 per cent in February. In spite of this, inflationary pressure refused to abate with headline inflation rising from 12.8 per cent in March to 17.1 per cent in July.
Again, the reason put forward by the MPC for further tightening when it met in July 2016 and voted to increase the MPR by 200 basis points from 12 per cent to 14 per cent was that an upward adjustment in interest rates would ‘’strongly signal not only the Bank’s commitment to price stability but also its desire to gradually achieve positive real interest rates’’ as well as provide the ‘’impetus for improving the liquidity of the foreign exchange market.’’
Notwithstanding monetary policy transmission lag, the presumption that positive real interest rates and increased capital inflows would materialize as corollaries is belied by the persistent inflationary pressure and the fact that the naira has remained weak with a wide margin between official and parallel market rates which continues to provide incentive for round forex round tripping and other sharp practices.
In its capital importation report for Q2 2016, the NBS stated that ‘’the total value of capital imported into Nigeria in the second quarter of 2016 was estimated to be $647.1 million, which represents a fall of 8.98% relative to the first quarter’’ adding that the continuing decline in the value of capital imported into the economy was not unconnected with the downturn in economic activities ‘’which may suggest less profitable opportunities for investment’’. By implication, there is a causal link between capital inflows and economic recession as foreign investors tend to shy away from troubled economies no matter how high the policy rate is raised.
So, it is evident that the weakening fundamentals of the economy, particularly the low output growth and rising unemployment, provide an opportunity to review the thrust of monetary policy. The recession confronting the economy and the prospects of negative growth to year-end provide strong grounds for easing monetary policy.
The monetary authority should recognize that the benefit of credibility in policy associated with inflation targeting is offset by real output losses from an overly tight policy. Further tightening the stance of monetary policy would not only weaken aggregate demand but also have an adverse effect on banking system stability given the already high non-performing loans in the books of Deposit Money Banks.
Indeed, the present economic reality calls for a rethink of monetary policy thrust so that the emphasis is on restarting inclusive economic growth and promoting employment creation while keeping an eye on price stability.
To this end, the MPC should vote to lower significantly the MPR when it meets for the fifth time in September 2016 as well as reduce the CRR from the current 22.5 per cent to say 20 per cent especially in view of the fact that the drivers of the current pressure on consumer prices are beyond the direct influence of monetary policy.
The CBN should spare no effort in ensuring that this time around, its attempt at easing liquidity into the system is directed at employment generating activities in the economy such as SMEs, infrastructure and agriculture.Dr. Uche Uwaleke, a Chartered Banker, is an Associate Professor of Finance and Head of Banking & Finance Department at Nasarawa State University Keffi.
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