The monetary policy committee (MPC) had its first meeting for the year just under a week ago. Unsurprisingly, they decided to hold all monetary variables fixed with the monetary policy rate (MPR) held at 14 percent. This means that despite the dynamics of the domestic economy and the upheavals in the global economy, the MPR has remained fixed for almost two years. It makes me wonder, should we really still care about the MPC?
First a bit of background to why I ask that question. The primary goal of monetary policy is to keep inflation in check. Inflation unfortunately is a tricky customer. One part of the inflation story depends on real factors like the money supply and costs and all that. A second part however depends on people’s expectations. Because people making decisions on prices and interest rates and so on have to guess what the future environment will look like, inflation also depends on people expectations. If people expect inflation to be lower in the future then inflation tends to be lower, because people act today like inflation will be lower. On the other hand, if people expect inflation to be higher then it tends to be higher. It is therefore in the interest of the monetary authorities to do what needs to be done to convince people that future inflation will be lower, if it wants lower inflation.
One of the ways the monetary authorities do this is to convince people that they are actually focused on fighting inflation and keeping it within its set target. Since the interest rate is the traditional tool for fighting inflation, they announce their interest rate targets in advance so that it is clear that they are acting to fight inflation. For instance, if inflation starts to rise and they announce that they will raise interest rates then people believe that they areactually going to do what it takes to prevent inflation from rising, so they lower their expectations about inflation, which actually leads to lower future inflation.
In most credible countries, when the monetary authorities say they will target a certain rate they usually try to hit their target. In the United states for instance, when the federal reserve bank says they will target a rate of two percent, it usually results in the federal funds rate being two percent and similar securities like short term treasury bills also being two percent. In South Africa, when the reserve bank sets a benchmark repo rate of six percent, you actually observe the rates for similar securities hover around six percent. In general, credible monetary authorities actually implement their announcements. They never raise or lower rates significantly without actually announcing it. Consequently, they never do something different from what they announce.
Which brings us to the Central Bank of Nigeria. The MPC is the monetary authority that sets and announces the target rate, but the central bank actually has to implement it in the market. If the MPC sets a target rate of 14 percent for instance, then if the CBN is implementing what it announces, its actual benchmark rate and similar securities should be around 14 percent. Ergoo, if the CBN is credible with its announcements, it should never systematically raise or lower rates without announcing it first.
Unfortunately, the data suggests that the CBN does not actually implement its interest rate announcements via the MPC. In the 28 months since the CBN fixed the MPR at 14 percent, data from other securities suggest that it has actually gone from a tightening cycle (raising rates) to an easing cycle (lowering rates) and more recently back to a tightening cycle again. For instance, between August 2016 and May 2018, rates for 91-day treasury bills dropped from 14.93 percent to 10 percent, indicating an easing cycle even though the CBN continually announced a MPR of 14 percent throughout the period. The same patterns are observed even with the CBNs own OMO securities. On the flip side and judging by the rates for treasury bills and OMO securities since last July, the CBN appears to have gone back to a tightening cycle even though its announcements via the MPC have indicated no change.
In general, the data suggests that the announcements of the MPC are really just announcements and the CBN does not actually implement them. So, should we actually take the announcements by the MPC seriously? The answer at this moment is no. It appears to be nothing more than a fulfilled obligation at this point in time. The cost of course is that people have to find an alternative way to judge if the CBN is credible and is really focused on its core mandate of fighting inflation.As has been demonstrated time again, the cost of a lack of credibility is higher inflation.
Dr Obikili is chief economist at Business Day
