This month the Central Bank of Nigeria’s (CBN) rate-setting committee (the Monetary Policy Committee — MPC) meets for the first time under its new governor. He, incidentally, did feel a need earlier to put his “manifesto” out. Much commentary attended his presentation; and the consensus was that he had managed to drop so many balls all at once. By how much did he miss the plot, though? Was he justified, for example, in his effort to pre-determine the monetary policy reaction function ahead of this month’s meeting? How did he plan to push policy through, fully aware that the committee votes on policy options on the economy, and that, ideally, even as governor, he has only one such vote?
Within the context of ongoing conversations around what central banks should be doing in the aftermath of the last global financial and economic crisis, some of the commentary on the new governor’s “maiden address” was unkind to him. Not just does the CBN have to work through the unprecedented policy responses prompted by the global financial crisis, one of the more real lessons of the crisis is that financial stability is as important for an economy’s health as is price stability. What ought the post-Sanusi CBN to do under this markedly changed circumstance? And what tools ought it to resort to?
To be fair to his critics, the new CBN governor did not dimension his tasks this lucidly. For the most part, he came across like a low-level treasury apparatchik. Still, he did allude to the need to define new objectives for the bank, in the light of the much-changed circumstance in which it has had to operate of late. In this, despite the initial antipathy to him, he is supported by new post-crisis research on monetary policy.
One of such papers, “Monetary Policy in the New Normal”, an IMF Staff Discussion Note released about two months ago, agrees that, going forward, although necessary, long-term price stability might not be a sufficient condition for overall macroeconomic stability. According to the paper, “… additional intermediate objectives (such as financial and external stability) may play a greater role than in the past. When possible, these should be targeted with new or rethought instruments (macroprudential tools, capital flow management, foreign exchange intervention). But should these prove insufficient, interest-rate policy might have to play a role.”
Much of the paper goes on to re-examine monetary policy from first principles, in the light of the diverse stimuli and responses thereto that have been unique to the last decade. The paper leaves as much unanswered, including how the new worry over financial stability may be properly married to monetary policy. The flattening of the Phillips curve during the recession (as inflation refused to respond to changes in employment count) especially in developed economies, and the significance of this is one other unknown. This effect is important in our case, because of our new central bank governor’s plan to include unemployment numbers in the design of monetary policy responses.
The IMF’s researchers proffer a slew of possible explanations for the weakening of the relationship between inflation and unemployment, including the failure of existing models to capture fully “the cyclical component of unemployment increases during the global financial crisis”, globalisation’s sanguine effects on inflation, and strengthened central banks’ inflation-busting credentials.
Still, none of these appears to support the CBN’s plan to bring unemployment numbers on board its models for monetary policymaking. This also ignores the technical hurdle, in our case, to doing so. Instead, the case is made for more “flexible inflation targeting”. Thankfully, the CBN, especially under its former governor never neared the point where it was able to implement strict inflation targeting, so technically the transition to a more flexible approach to achieving price stability ought to be easier.
And, what about central bank independence? This matters because the appointing authorities for the office of CBN governor may be loth to strengthen in the light of their run in with the last but one governor. Whereas a weaker CBN governor might please the treasury, the IMF’s research concludes that “Independence is clearly still desirable with regard to price stability”. If however the CBN’s mandate broadens, especially because financial stability is now included in its remit, but also because the new CBN governor describes quasi-fiscal interventions as critical to his vision of the CBN’s trajectory, then the Fund’s researchers think that “independence” “may prove politically difficult”.
It describes as “critical” under these circumstances protection of the “independence of the role of central banks in protecting price stability, while allowing adequate government oversight over their new responsibilities for financial stability”.