Broad Street Journal-Monetary Policy Management in Nigeria in the Context of Uncertainty

By O. A. Uchendu

Monetary management is the aspect of macroeconomic management which is undertaken on behalf of government by the Central Bank of Nigeria, CBN, which is the sole monetary authority in Nigeria. The tool for carrying out the task of monetary management which is one of the core functions of the bank is monetary policy. The monetary policy-making process is analogous to a circular string of activities, in this case, including policy formulation, policy implementation and policy evaluation. The process is fairly complex involving quite a number of activities in each of the compartments. When collapsed, a few activities icons can be isolated and described as we have attempted to do here. These activities include: deciding primary focus of monetary policy; deciding on a monetary policy strategy or framework/policy objectives; choosing a nominal anchor; setting relevant targets; programming/modeling; deciding policy instruments; day-to-day conduct of monetary policy (routine activities including communication and evaluation of outcomes. These activities are in practice, intertwined and not necessarily sequenced as presented above.

Deciding the Primary Focus of Monetary Policy: The objectives of monetary policy are well documented — price stability, high and sustainable output and employment, visible external sector, among others. Yet, every central bank must identify the primary focus of its own monetary policy. Monetary policy is widely acknowledged as a potent instrument for stabilizing inflation and output

over the business cycle. It is however, unable to address or accommodate potential conflicts of objectives that arise from the stimulations pursuit of both goals. Each of the goals is important in its own right. In many countries, what the primary focus of policy should be is a legal matter. In recent times, many countries mandate their monetary authorities to pursue inflation stabilisation as the overriding goal of monetary policy. It is also true that many developing countries still insist on dual mandate for monetary policy. Nigeria is in this category. The CBN is expected to conduct monetary policy in such a manner as to ensure price and output stability in the long run. In principle, this means that bank’s monetary policy stance at any point in time has to reflect concerns for not only inflation but also the overall growth and stability of the domestic economy.

Choosing Monetary Policy Strategy: Several monetary policy strategies have evolved over the years: exchange rate targeting, monetary targeting, nominal GDP targeting, inflation targeting, price level targeting and so on. The central bank either chooses from this menu of strategies or develops one. What is key is that there must be a clear strategy for the conduct and evaluation of monetary policy. Deciding on a strategy is no easy task as the decision must be predicated on a strong conviction, deriving essentially from research, that the particular strategy would deliver better monetary policy outcomes. Country peculiarities are usually taken into consideration in choosing a monetary policy strategy. The Central Bank of Nigeria, CBN, emplo

employs monetary targeting as the framework for its monetary policy. This framework is quite popular and relies on the ability of the central bank to influence domestic macroeconomic conditions by controlling money and credit. The strategy requires in the minimum that the bank identifies both an operating target and an intermediate target. The CBN uses reserve money as its operating target and broad money (M2) as the intermediate target of monetary policy.

Nominal Anchor: A nominal anchor for monetary policy is a variable or device which the central bank uses to pin down expectations of private agents about the nominal price level or its path or about what the bank might do with respect to achieving that path (Mishkin, 2007; Knigman, 2003). An explicit nominal anchor for monetary policy can take several forms: a currency board, a money growth target, an exchange rate target, an inflation target, among others, (Mishkin, 2007). Loosely interpreted, nominal anchor may refer to monetary policy strategy (Truman, 2003). Broadly, nominal anchors are grouped into two quantity-based nominal anchors and price-based nominal anchors. The quantity based nominal anchors target money while the price-based nominal anchors target price variables, exchange rate or interest rate. Currently, the CBN uses broad money supply (M2) target as the nominal anchor for monetary policy.

Monetary Policy Targets: The targets of monetary policy may be categorised into three — the operating target, the international target and the final targets. The central bank app

applies the operating target to influence the intermediate target and ultimately, the final objectives of monetary policy. For Nigeria, the operating target is the reserve money, made up of currency in circulation and bank deposits with the central bank while the intermediate target is broad money (M2). The final targets of monetary policy are mainly inflation and domestic output.

Monetary Programme/Model: The monetary policy formulation process is usually supported with a monetary programme which defines the quantitative targets to be attained. Most countries of the world have moved from the simple Polak model which looks at only the monetary and external sectors of the economy, to the financial programming framework which considers four key sectors of the economy — real sector, fiscal sector, external sector and monetary sector. The monetary programmes is prepared for a period of two years and reviewed as the need arises.

Monetary Policy Instruments: Monetary policy instruments are the tools at the disposal of the central bank to conduct or implement monetary policy. These are direct and indirect instruments. Direct instruments include sectoral credit allocation credit ceilings and cash reserve requirements, administrative fixing of interest and exchange rates, and imposition of special deposits. The indirect or market-based open market operations which involves the supply or withdrawal of liquidity from the economy by the central bank through secondary markets dealings in treasury securities as well as the issuance/purchase of

of central bank securities; reserve requirements which specifies the proportion of a bank’s total deposit liabilities that should be kept with the central bank; and discount window operations under which the central bank performs the role of tender of last resort to the deposit money banks. Open market operations may be undertaken through outright transactions or through repurchase transactions. Repurchase transactions are temporary and are usually reversed at the expiration of the contract.

Standing facilities may be applied to steer market interest rates towards the central bank rate and in the process prevent interest rate volatility. Direct monetary controls are prevalent where the financial markets are not well developed as opposed to indirect or market based systems in countries with well developed financial markets. I all cases, moral suasion is applied to influence the market.

Day-to-Day Monetary Management: The day-to-day conduct of monetary policy by the CBN relies on a theoretical framework which links the operating target (RM) to the international target (M2) and to the final objectives of price and output stability. In principle, the bank is able to control the RM which has a definite impact on the broad money. Changes in broad money influence the domestic price level and output.

Institutional Framework: In Nigeria, the Monetary Policy Department of the CBN articulates the monetary policy framework and produces draft monetary programme which is reviewed by the Monetary Policy Technical

Committee, MPTC, and finally by the Monetary Policy Committee, MPC. The MPC deliberates and approves the monetary policy proposals which are subsequently implemented by the operational departments. The MPC meets every other month and has a calendar of meetings. It is the highest authority on monetary policy issues at the CBN. In line with the new CBN Act, the Committee must sit at least four times in a year. Because the CBN has instrument independence, its monetary policy opinions are not vetted by any higher authority. The committee comprises the governor and four of his deputies, two external board members, the permanent secretary, minister of finance and a secretary, usually the head of Monetary Policy Department. Following the enactment of the new CBN law, the membership of the committee is expected to be expanded to include three appointees of the president and two of the governor of the bank.

At the CBN there are other supporting institutional arrangements. These include the Monetary Policy Technical Committee, MPTC, and the Monetary Policy Implementation Committee, MPIC, Fiscal Liquidity and Advisory Committee, FLAC, and Liquidity Forecasting Committee, LFC. These committees perform different but complementary roles in the formulation and implementation of monetary policy at the CBN.

Policy Implementation: Framework, Communication and Evaluation: Prior to the banking sector consolidation exercise that was concluded in December 2005, the framework for monetary policy implementation had undergone some modifications. These included the shift from the use of direct mone

monetary policy control instruments to the indirect (market-based) instruments with the commencement of OMO operations in 1993, and the adjustment in policy horizon to a two-year medium-term framework. Although the objectives of monetary policy have remained basically the same with reserve money and M2 as the operating and intermediate targets, there have been some other improvements since 2006. For instance, partly to address inter-bank rate volatility, the CBN introduced a new framework for the implementation of monetary policy in December 2006. As part of the new framework, the bank established a standing deposit and lending facility and replaced the MRR with the MPR which was set at 10.0 per cent. The entire system was designed as a corridor with the lending facility as the upper bound of the corridor while the deposit facility served as the lower bound. The entire corridor had a width of 600 basis points with the MPR at the centre at commencement.

The MPR was reviewed by the MPC at its subsequent sittings as deemed appropriate by the committee and on the recommendations of the MPTC. Currently, the deposit facility attracts zero per cent interest while the lending facility is available at the MPR.

OMO, conducted using the Nigerian Treasury Bills, NTBs, remains the primary instrument of monetary policy, supported by the cash reserve requirement, CRR, and discount window operations.

Monetary policy decisions are communicated routinely to the markets and the general public as part of the bank’s transparency and accountability objectives. At the end o

end of every MPC meeting, a communiqué is issued and the public is able to assess the monetary policy stance of the bank. Various individuals, organisations, and the mass media express opinion on the stance of monetary policy process and those opinions and commentaries feedback to the monetary policy process. The periodic reporting of the activities of the bank to the National Assembly has also contributed to the intensified public scrutiny of the bank’s monetary policy process. Effective communication with the public helps to create an enabling environment for effective monetary policy because it makes it possible for the decision of the central bank to be subjected to public scrutiny and enhances the understanding of what the central bank does. Transparency, through effective communication with the public, has become critical for central banks, as expectations held by the public on the future course of monetary policy impact on the transmission mechanism of monetary policy. It makes monetary policy more predictable. If policy responses are properly anticipated, the transmission mechanism could be shortened as that the movements through investment and consumption are shortened and the required economic adjustments speeded up. Correct anticipation of monetary policy could also reduce interest rates and financial markets’ volatility. Transparency may entail high degree of predictability.

Overall, the monetary policy process has become more transparent and accountable since the MPC was introduced in 1999.

Nature of Uncertainty in Monetary Management in Nigeria:

‘Uncertainty is not just an important feature of the monetary policy landscape; it is the defining characteristic of that landscape’ (Greenspan, 2003). As noted earlier, in Nigeria the major sources of uncertainty in the conduct of monetary policy are the data, the transmission mechanism and the fiscal environment.

Data: A lot of data go into the analyses that inform monetary policy proposals. The bulk of the data are monetary data which are typically subject to frequent revision. In addition, quality concerns are often high with other non-monetary data such as real sector statistics, many of which are infrequently available. Sometimes, the timing of availability of the real sector statistics, with the exception of inflation, is less predictable. These factors increase the data risks in the formulation and evaluation of monetary policy.

Transmission Mechanism: In developing countries especially, little is known about the transmission mechanism of monetary policy. Nigeria is not an exception. Although some studies have been conduce and many more are underway, knowledge of the relative strengths of the transmission channels of monetary policy is still at the rudimentary level. An added dimension is that the transmission mechanism of monetary policy is not fixed. Over time changes are bound to occur. Some channels that used to be strong either get degraded in importance or become outright irrelevant. Monetary policy is formulated with some assumptions about the path through which policy impacts on the economy. The risk therefore is the possibility th

that the assumed channel of transmission is wrong (irrelevant) or that the assumed magnitude of impact is wrong by some significant margin. These uncertainties add to the complications associated with monetary management which is ordinarily high considering the fact that the relationships underlying the economy’s structure change over time in ways that are difficult to anticipate. For instance, what constitutes money has expanded by the introduction of technology-backed proliferation of financial products, which have tended to alter the empirical relationship between economic activity, inflation and the broad boney (M2) in Nigeria.

Uncertain Fiscal Policy Environment: Fiscal policy matters a great deal for monetary policy. In fact, to a large extent, it dictates the monetary policy stance. For instance, if in any period fiscal policy is considered lax, monetary policy has to be reasonably restrictive to maintain both internal and external balance. The major challenge however, is how to cope with surprises. Fiscal surprises undermine monetary policy substantially. The risk is enshrined in the possibility of that monetary policy grossly underestimates or overestimates the magnitude of needed intervention.

Dealing with Uncertainty: As a consequence of the uncertainties discussed in section three above, the conduct of monetary policy by the CBN involves elements of risk management, a process that requires an understanding of the many sources of risk and uncertainty that the monetary policy policymakers face, and devising, in light of the risks, a st

strategy for policy aimed at increasing the likelihood of achieving the goals of policy — price stability and the maximum sustainable economic growth — over time.

With respect to knowledge of the transmission mechanism and underlying macro relationships, the CBN encourages and sponsors research and utilises the outputs of those studies in making an opinion about monetary policy transmission at any point in time. In practical terms, monetary policy makers at the bank learn extensively from their own and other countries’ experiences in making assumptions about the transmission path of monetary policy. Over time such experiences are formalised through independent as well as bank-led studies and knowledge sharing. A third way in which the bank deals with uncertainty about monetary transmission is through the development of institutional memory. Efforts in this direction have received a boost in recent years as part of the internal reform initiatives of the bank. Knowledge management is currently being deployed as means of developing and preserving institutional memory which is essential in dealing with uncertainty about the transmission mechanism of monetary policy and other issues.

With respect to uncertainties around data, the bank relies a lot on knowledge of the stable characteristics of certain variables (data) in forming opinion about the reliability of available data. In order to minimise the quality risk with monetary and other statistics, the bank recently established a separate Statistics Department to liaise with the operational departments where monetary statistics are generated

and also with external data agencies. The bank invests a lot in uplifting the capacity of her staff to manage data at different levels. Likewise, it collaborates with the country’s statistical agency, the NBS, to ensure early availability and improvement in the quality of real sector statistics which are critical to monetary policy-making. More crucially, as part of the bank’s reform initiatives under project EAGLES, the bank has made a lot of progress with the automation of its key data generating processes by deploying the e-FASS, ERP and T24, to aid data collection, storage and retrieval.

In dealing with fiscal policy uncertainty, the bank’s major strategy continues to be to seek closer and more effective coordination with the fiscal authorities. This happens at different levels. The more significant ones are the mechanisms of the FLAC and direct involvement of the ministry of finance in monetary policy formulation. The permanent secretary, MOF, is an ex-officio member of the MPC. Through both channels the bank receives early signals about major fiscal injections. A complementary strategy is that the MPC factors into the decision process, staff analysis and projections of movement revenues, expenditure and borrowing requirements at the federal level. This is usually informed by such developments as the international oil prices, government budget and past fiscal behaviours.

Conclusion: Uncertainty remains a major challenge for monetary policy not only in Nigeria but every where else. Central banks generally continue to find better ways of dealing with u