By Omoh Gabriel, Business Editor
The macro-economic goals any government seeks to achieve at any given time are full employment of human and material resources, price stability, economic growth, balance of payment position and stable exchange rate. These goals are prescribed and targets set on annual basis through fiscal and monetary policies. For each of these policy trade off are needed in other to achieve macro economic stability. Policy makers have to chose how much of unemployment is desirable to achieve a given level of price stability. In all price stability preoccupies modern central bankers. Globally, inflation targeting has taken the central stage of economic policy. Efforts of central banks has shifted from interest rate to inflation targeting.
While other central bank are busy designing policy to target inflation in order to ensure quality for the citizenry through low prices of goods and services, the Central Bank of Nigeria is saddled with interest rate monitor and banking supervision. It has almost left its core mandate in recent time
Inflation targeting as practised in other developing and developed economy, is an economic policy in which a central bank estimates and makes public a projected, or “target”, inflation rate and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools.
Because interest rates and the inflation rate tend to be inversely related, the likely moves of the central bank to raise or lower interest rates become more transparent under the policy of inflation targeting.
An analysis of external and fiscal dominance in the Nigerian economy show that government pursuit of low inflation rate and an exchange rate stability in the last twenty years or so has not achieved any measure of success and that none of the applied strategies has been particularly appealing.
The CBN it seems have been adopting a long-run target for inflation combined with a free float. This has not yielded the needed results. Government it would appear is under pressure to deliver the dividend of democracy and is looking for quick win situation.
As a result the International Monetary Fund, IMF, in its 2010 article iv consultation with Nigerian urged the CBN to focus more on inflation targeting, instead of the current focus on banking supervision saying the naira was currently over-valued. The board also expressed concern about potentially conflicting objectives of the Central Bank of Nigeria Monetary policy, advising it to scale back its development finance initiatives which in them selves are extra budgetary provisions that fuel inflation.
According to the IMF directors expressed concerns about potentially conflicting objectives of monetary policy and advised that the policy framework should focus more clearly on price stability.
The inflation risk hinges crucially on the 2011 budget. The National Assembly has passed a more expansionary budget of N4.6 trillion for 2011, undermining the CBN’s ability to deliver on inflation.
The CBN has shown that it is ill equipped to fight inflation as inflation has been stuck in the low double digits for the past two years and foreign reserves have been falling because the CBN has focussed on maintaining exchange rate stability and low interest rates. The fiscal stimulus intensified in 2010, notwithstanding the already solid growth performance and high inflation.
The financial sector has also shown the inability of the apex bank to control interest rates as call and OBB rates rose to averages of 8.45 and 7.43 per cent, respectively, in October 2010, in response to the upward review of the MPR and IT challenges experienced in September, 2010. The rates, however, moderated to 8.06 and 6.86 per cent in December 2010, while MPR remained at 6.25 per cent. The average maximum lending rate decline from 22.20 in September, 2010 to 21.84 per cent in November 2010. The average prime lending rate also fell from 16.66 in September to 16.11 per cent November, 2010. The weighted average savings rate declined consistently from 3.2 and 1.95 per cent in March and June, 2010 to 1.49 and 1.48 per cent in September and November, 2010, respectively. The consolidated deposit rate which declined from 2.09 per cent in June to 2.07 per cent in September rose to 2.36 per cent in November, 2010. Thus, the spread between the average maximum lending rate and the consolidated deposit rate widened from 19.94 per cent in June to 20.14 per cent September, before narrowing to 19.48 per cen
If the CBN were equipped and had adopted inflation targeting if inflation appears to be above the target, it will raise interest rates. This usually (but not always) has the effect over time of cooling the economy and bringing down inflation; if inflation appears to be below the target, the bank is likely to lower interest rates. This usually has the effect over time of accelerating the economy and raising inflation.
Under inflation targeting policy, investors know what the central bank considers the target inflation rate to be and therefore may more easily factor in likely interest rate changes in their investment choices. This is viewed by inflation targeters as leading to increased economic stability.
Inflation targeting is not new as early proposals of monetary systems targeting the price level or the inflation rate, rather than the exchange rate, followed the general crisis of the gold standard after World War I.
Irving Fisher an Economist proposed a “compensated dollar” system in which the gold content in paper money would vary with the price of goods in terms of gold, so that the price level in terms of paper money would stay fixed. Fisher’s proposal was a first attempt to target prices while retaining the automatic functioning of the gold standard. In his Tract on Monetary Reform (1923), John Maynard Keynes advocated what is now called an inflation targeting scheme. In the context of sudden inflations and deflations in the international economy right after World War I, Keynes recommended a policy of exchange rate flexibility, appreciating the currency as a response to international inflation and depreciating it when there are international deflationary forces, so that internal prices remained more or less stable.
Interest in inflation targeting schemes waned during the Bretton Woods system (1944–1971), as they are normally inconsistent with exchange rate pegs such as those prevailing during three decades after World War II. Inflation targeting was pioneered in New Zealand in 1990, and is now also in use by the central banks in United Kingdom Bank of England, Canada Bank of Canada, Australia Reserve Bank of Australia, South Korea Bank of Korea, Egypt, South Africa South African Reserve Bank, Iceland Central Bank of Iceland and Brazil Brazilian Central Bank, among other countries, and there is some empirical evidence that it does what its advocates claim.
In recent years industrial countries have phased out exchange rate pegs and monetary aggregates while non-industrial countries with flexible exchange rates have adopted single target regimes. Global integration has led to more flexible exchange rate regimes and agreement on merits of low-inflation;
Financial development has reduced the effectiveness of monetary aggregates.
Money aggregate targets are still the tools being used by the CBN hence most of the policy prescriptions run into a hitch. Although the CBN has held series of workshops and commissioned some experts to study the possibility of introducing inflation monitoring in Nigeria it has so far not taken the bull by the horns to initiate the policy. The big question is when will it do so?
