CBN: Pondering new monetary policy framework amid inflation

Rising inflation I n a report released last week, analysts at Financial Derivatives Company Limited (FDC) forecast that Nigeria’s inflation likely rose to 22.67 per cent in April from 22.04 per cent in March as a result of rising food prices. According to the analysts, “despite the deceleration in the global food index for 12 consecutive months (129 points) and relatively stable exchange rate, both imported and locally produced commodities in Nigeria have remained high.”

The analysts, who attributed the increase in domestic food prices mainly to supply shortfalls occasioned by the planting season, said that the rise in imported com- modity prices was “largely due to the transmission lag between global events and the impact in the domestic economy.” They said: “Consumer price inflation has increased sharply since the Russia- Ukraine war in February 2022, disrupting energy and commodity prices. The major inflation culprit this time will be the planting season, which is re- ducing commodity supply. This is being compounded by a boost in aggregate demand (Easter and Ramadan celebrations) and an increase in liquidity (re-introduc- tion of old naira notes). Food infla- tion is expected to spike by 0.17 to 24.62 per cent from 24.45 per cent in March.”

On whether the uptrend in inflation would lead to the CBN slowing down its interest rate hikes( the sixth was announced in March), the analysts said: “Most Central Banks have been aggressive in the fight against spiraling inflation in the last year as supply chain disruptions due to the Russia-Ukraine war exacerbated inflationary pressures. “However, in recent times, the gradual slowdown in consumer price inflation, especially in ad- vanced economies is forcing poli- cymakers to rethink policy direc- tion. At the recently concluded meeting, the US Fed raised the benchmark interest rates by only 25bps and signaled a possible halt in interest rate hikes. “However, Nigerian inflation has remained stubbornly high despite the CBN’s hawkish mon- etary policy stance. If our projec- tions are accurate, inflation will be 13.67 per cent above the upper band of the CBN’s inflation target (9%). This is raising questions as to whether the Nigerian MPC will go in the US direction or maintain its aggressive monetary policy stance at the next MPC meeting on May 22/23.” MPD Retreat Clearly, the CBN was already considering a fresh strategy to effectively tackle inflation as the Director, Monetary Policy Depart- ment (MPD) at the apex bank, Dr. Hassan Mahmud, announced over the weekend that the regulator was mulling migrating to a new monetary policy framework from its current monetary targeting framework. Mahmud, who disclosed this at the MPD’s 2022 Retreat, with the theme, “Monetary Targeting Policy Framework in Nigeria – An Appraisal of its Continued Rele- vance to the Price Stability Mandate,” held in Lagos, stated that the need to review monetary targeting, which Nigeria adopted as its main policy framework since the 1990s, had become necessary given that, in recent years, doubts had arisen over the effectiveness of the framework in achieving price stability in the country. He said: “At the Central Bank of Nigeria, we migrated over the years from an Exchange Rate Targeting Framework to a Mon- etary Targeting Framework and a subsequent veiled attempt at a phased migration to Inflation Targeting, adopting a hybrid ap- proach between the Monetary Targeting Framework with ele- ments of Inflation Targeting.

“Monetary targeting is a policy framework that involves setting a target for a monetary aggre- gate, such as the money supply, and adjusting monetary policy to achieve that target. In the case of Nigeria, monetary targeting was adopted as the main policy framework since the 1990s, focus- ing on controlling the growth of the money supply to achieve price stability. “However, over time, the effec- tiveness of monetary targeting in achieving price stability in Nige- ria 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 finan- cial innovation and the growth of non-bank financial institutions. In addition, the relationship be- tween the money supply and infla- tion has become less predictable in recent years, further complicat- ing the use of monetary targeting as a policy tool.” He noted that despite the chal- lenges of monetary targeting, its proponents argue that it remains a relevant policy framework in Nigeria as it provides a clear an- chor for monetary policy and also helps to anchor inflation expec- tations, which is important for maintaining price stability. However, the MPD Director said the CBN would still need to review the continued relevance of the monetary targeting frame- work to address the series of new and developing shocks impacting the country’s economy, as well as the advantages that the apex bank may derive from migrating to an inflation targeting frame- work. Inflation targeting In a chat with journalists on the sidelines of the event, Mahmud also stated that with currencies outside the banking system undermining the CBN’s tightening measures, such as Monetary Policy Rate (MPR) and Cash Reserve Ratio(CRR) hikes, the apex bank was at the stage where it had to start to focus on its core mandate-price stability- “and using inflation itself as a target in terms of monetary ag- gregate.” He noted that targeting infla- tion “explicitly” would require the CBN carrying out its research and projecting an inflation range which it would announce to the public. He pointed out that inflation targeting has been the adopted monetary policy framework globally particularly post the 2007- 2009 global financial crisis, noting that it was also a requirement for ECOWAS and African Union member countries’ Central Banks to adopt inflation targeting. He said that in addition to inviting an official of the International Monetary Fund (IMF), the MPD also invited the Director of Research at the central bank of Kenya, the Director of Research, central bank of Ghana and officials of other countries that have all adopted the inflation targeting framework, to the Retreat to share their experiences.

Responding to a question on whether it was relevant for the CBN to consider adopting in- flation targeting given global headwinds such as the Russia- Ukraine war, Mahmud said: “It is extremely relevant because the point that is being made now is that central banks should focus on their primary mandate.” He added: “Central banks are into so many things particularly in economies that are not well developed. But the crisis that fol- lowed Covid made it clear that central banks must deal with in- flation decisively and also sustain that low level of inflation that is conducive for growth. “So it is in that perspective that it is becoming more perti- nent. And like I said, it is also part of the convergence criteria requirement that all ECOWAS member countries adopt inflation targeting. So we are conforming with that global best practice and also with the understanding of the specificities of our domestic economy.” In his remarks at the event, the Deputy Governor, Economic Policy Directorate at the CBN, Dr. Kingsley Obiora, commended Dr Mahmud and his team for hold- ing the Retreat, according to him, “at such a critical time in the de- velopments across the global and domestic economies.”

He said: “In today’s economy, rapid technological advance- ments and increasing competi- tion are changing not only the way we do business but also the definition of money. “The rapidly changing mac- roeconomic environment has meant that the continued reli- ance 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 diffi- cult to set appropriate targets for money supply growth. “It has become pertinent against this backdrop for the Bank to consider the pros and cons of a transition to a new mon- etary policy framework in a bid to improve our ability to continue to anchor inflation expectations.” Conclusion Analysts believe that given the massive damage inflation inflicts on economies, the CBN’s Mone- tary Policy Department would be justified to recommend a migra- tion from monetary targeting to an inflation targeting framework.

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