Central banks globally predominantly use the movement in interest rates to adjust money supply to ensure the economy continues to run optimally. In the long run, output, which is typically measured by the movement of gross domestic product (GDP) is fixed and so any changes in the money supply only causes a change in prices of goods and services within an economy.
The current economic climate in Nigeria can be categorized as hyper inflationary and being in a state of disequilibrium. For starters, Money supply (M3) is a measure of the money supply which includes M2 large time deposits, institutional money market funds, repo or short term repurchase agreements and larger liquid assets. The net foreign and domestic assets which M3 captures provides a comprehensive view of the monetary position in the economy. The direction of M3 has been on the rise for the past 6 months, stoking further inflationary pressure.
On the fiscal side, according to the National Bureau of Statistics report, the Federal Account Allocation Committee (FAAC) has consistently disbursed over N1.1trn to the three tiers of government over the past 9 months. The quantum of liquidity disbursed, coupled with low productivity, and other endogenous variables such as, floating the local currency, lower oil production, insecurity, and lower crop yields have triggered a cost-of-living crisis amongst household and Micro Small and Medium Enterprises (MSMEs).
In a recession, or in this instance, a high inflationary environment, consumers stop or reduce spending as much as they used to; business production declines triggering layoffs and a grinding halt to investments. For example, since the Central Bank of Nigeria took the decision to float the currency, the cost of imported goods will continue to increase, making it impossible to continue operations. One can simply go to the ports and observe the volume of goods that are waiting to be cleared. My guess is that businesses plan with the approved budget of the government, especially when it relates to the set foreign exchange rate which was based on the approved budget of N800/$1. However, since the Central Bank has floated the currency, it also means that the clearing cost rate would also vary from time to time, which is not a good proposition for any business who plans to remain in business. When those goods are cleared, the business owner would be operating at a loss because the fundamental business case to sell the goods at a set price has changed, talk less of the imported inflation. To achieve a degree of price stability, the Central Bank should revert to the approved exchange rate.
Twin Objectives
In view of the forgoing, economists have argued that better fiscal and monetary policy coordination is needed to realign prices to return to equilibrium. The monetary policymaker must balance price and output objectives. Presently, the Central Bank has embarked on inflation targeting as the predominant tool for monetary policy. In doing so, the monetary policy rate will naturally increase to push down inflation which has remained sticky at 29.9% according to the NBS. While many central banks have experimented over the years with explicit targets for money growth, such targets have become much less common, because the correlation between money and prices is harder to gauge than it once was. Central banks will generally admit that they still pay close attention to stabilizing output to keep the economy growing and unemployment relatively low.
Monetary policy is not the only tool used in managing aggregate demand for goods and services. Fiscal policy, which is essentially taxation and expenditure, is an important tool government uses to spur growth. However, when the quantum of liquidity pumped into the economy is not coordinated and producing the desired outcome in the real sector, the policy choice left becomes very difficult to make.
Stabilization Policy
Stabilization policy is the modification of economic policies by governments to support economic growth and development. A stabilization policy is a solution used by governments to mitigate unpredictable price fluctuations that harm price levels in an economy and by extension the GDP. It is frequently employed as an economic and political tool to maintain the economy’s well-being.
The policy can be either fiscal or monetary, or a combination of both and could be expansionary or contractionary. Economists believe that monetary policy is more effective at economic stabilization—because central banks can act more quickly than government and because it is more insulated from political considerations (Elmendorf and Furman 2008).
Business cycles are comprised of upswings and downswings in the broad measure of economic activities. And monetary policy plays a crucial role in moderating the speed of volatility of the swings to mitigate inflationary pressures. Simply put, the main objective of monetary policy is to ensure that there are no disturbances of economic activities originating from monetary influences. Above all, monetary policy must be applied to control the level of aggregate demand. It can decisively contribute to the adjustment of changes of demand to the given real potential of aggregate supply. Only if monetary policy is consistently used for financing expansionary processes possible in real terms, is a relatively stable development of the price level guaranteed.
In practice, as mentioned above, the level of M3 is significantly stoking inflationary pressure and the monetary policy tool of choice of the Central Bank has been open market operations (OMO). While OMO has been effectively used in other jurisdictions, this tool of choice in the context of the Nigerian economy is very costly because the transmission mechanism for OMO is short tenured. With a maximum tenor of 1 year, the excess liquidity the Central Bank has deemed will be removed from circulation at the current treasury rate of around 19%. Once it matures, either the Central Bank conducts another round of OMO or allows the monies mopped up to go back into circulation.
Difficult Policy Choice
In conclusion, to achieve price equilibrium in the economy, the fiscal and monetary authorities will have to make tough decisions for the public good.. For starters, the disbursements from Federation Account Allocation Committee will need to be reduced by 30% – 50% in the first instance, and the savings from FAAC would be saved on behalf of the three tiers of government as a rainy-day fund, and to be largely earmarked for infrastructure projects. On the monetary side, because open market operation is too expensive, a blunt instrument that has been used in the past is stabilization securities, which in practice is to sequester excess liquidity in the banking sector at 0% for as long as the Central Bank deems necessary to achieve price stability.
Prof. Joseph Nnanna
Chief Economist Development Bank of Nigeria
The views expressed in this article and are those of the author; they do not necessarily reflect Development Bank of Nigeria policy.
