Inflation targeting and CBN’s self-imposed accountability test

With the adoption of inflation targeting, the new leadership of the Central Bank of Nigeria (CBN) has not only raised the bar of accountability and demystified monetary policy conduct but has also handed the public the hangman’s noose should it fail in its most important mandate, achieving price stability, GEOFF IYATSE writes.

The first time it was mentioned at a gathering of Nigerian central bankers in recent times, it was treated as a policy option that could be applied to an inflation crisis that has defied several approaches. But at the weekend, the Governor of the Central Bank of Nigeria (CBN), Olayemi Cardoso, told an impatient gathering of bankers and allied professionals at the Annual Bankers’ Dinner in Lagos that inflation targeting has been adopted as a policy choice.

The audience, who converged on the main bowl of Eko Hotels and Suites, exploded in applause, perhaps before they took a deep breath to ponder the meaning and benefits of the approach in reining in stubbornly high runaway inflation.

It is not clear if the potency of the relatively novel framework was the trigger of the instantaneous approval or if the participants were merely fascinated by anything else different from seemingly failed monetary targeting. In any case, Cardoso scored a point with the mention of inflation targeting as the new policy direction as opposed to an option.

Perhaps a few of the participants only heard of the monetary jargon as invented by New Zealand as recently as 1989. Cardoso himself had too much to cover in his one-and-half-hour speech to think of explaining how the concept works in practical terms. That the phrase – ‘inflation targeting’ – was mentioned once in the 37-page written presentation underpins the attention it received beyond the announcement that it has been “adopted” by the apex bank.

The applause, the approval, has a long and interesting historical path. In May 2022 when the monetary authority activated the current restrictive policy circle, the headline inflation was 16.8 per cent. About 18 months into the hawkish campaign that has raised the interest rate by 63 per cent or 7.25 percentage points, inflation has reached a frightening high double-digit of 27.3 per cent.

Without an appropriate and timely response, Cardoso’s predecessor, Godwin Emefiele, said, the inflationary pressure would have been worse. But that fell short of the honesty required of a regulator. At the first monetary policy rate (MPR) hike in the circle last year, he said the action was taken to rein in inflation and achieve price stability. It was bad that the target was not met but worse that the authority could only guess how bad the situation could have been without a policy response.

Cardoso, during the second major public speech since his appointment, admitted the failure of money base targeting, saying: “I, together with my team at the Central Bank have been focused on doing so in the past two months. We have critically reviewed the effectiveness of the Central Bank’s monetary policy tools and have spent time fixing the transmission mechanism to ensure the decisions of MPC (Monetary Policy Committee) meetings actually result in desired objectives. For quite some time, there has been a dislocation of our monetary transmission mechanisms rendering the MPC meetings largely ineffective”.

The CBN chief only echoed a position made over time by experts. Monetary base targeting is largely theoretical for factors ranging from undeveloped financial systems to low credit penetration. In developed markets, the anchor interest rate feeds directly and instantaneously into the cost of formal commercial credits, thus increasing the cost of borrowing and tightening liquidity.

In practice, the monetary transmission belt is as strong as the proportion of individuals and businesses that are integrated into the financial system and have access to formal credits.

Of course, in recent years, Nigeria, through the financial inclusion secretariat domiciled in the CBN, has made some progress in expanding the financial net. Yet, the World Bank said about 64 million individuals are unbanked, suggesting that there is still a long walk to go in achieving full financial inclusion. Except, the journey is quickened and the credit market is reasonably ‘democratised, a credit-led economy, which is required for effective monetary policy, is yet a dream.

This shortcoming makes a nominal anchor like a money base a tough choice in controlling inflation. But inflation targeting is less cumbersome and offers a more straightforward process, at least in theory. This requires the central bank to forecast the future path of inflation, and compares it with the target price level, which reflects the rate the government believes is appropriate for the economy.

The difference between the forecast and the target determines how much money supply determinants have to be adjusted. The framework has gained popularity since December 1989 when New Zealand first experimented with it. Ghana, Kenya, South Africa and a few other African countries have jumped on the bandwagon, while Nigeria continued with monetary targeting. Nigeria had equally experimented with exchange rate targeting, a hybrid of different frameworks and implicit inflation targeting before migrating fully to monetary targeting, which seeks the adjustment of other indicators to achieve pre-determined monetary aggregates considered appropriate to achieve price stability. Sadly, modelling the money supply in the country is kneecapped by informality that defines both economic activities and financial transactions.

A key element of inflation targeting is the public declaration of the explicit target, which could be a point target as in the case of the United States and the United Kingdom, a range with lower and upper limits with India as an example or a symmetrical range around a midpoint as adopted by some Asian countries such as Philippines and Indonesia.

There is no doubt that the framework is still evolving but economists admit the approach’s allowance for monetary policymakers to ring-fence the local market and respond to shocks to the domestic economy without the usual distortions from external economies is one of its winning streaks. Inflation targeting also demands more transparency as central banks are required to maintain regular channels of communication with the public, thus helping to anchor inflation expectations, which equates actual inflation in macroeconomic theory. That means the usual tendencies to inflate prices are proactively checked in an inflation-targeting regime.

Cardoso referred to the essence of transparency in achieving price stability during his speech at the Bankers’ Night but in an overt reference to foreign exchange stability. “It is imperative that we provide transparency and create a market environment that allows fair determination of exchange rates, ensuring stability for businesses and individuals alike,” he stressed.

An explicit numerical inflation target in the policy choice also tends to increase a central bank’s accountability. Hence, it is less likely that the CBN would fall into the usual time-inconsistency trap. This is particularly important in checkmating distortions from the culture of weak institutions, hence Nigeria could build public support for a more independent and accountable CBN.

Perhaps, Cardoso is also mindful of the important virtue when he declared: “We will stand by Nigeria and Nigerians. Our actions will be fully guided by the principles of transparency, responsibility and a deep commitment to Nigeria’s progress.”

Of course, inflation targeting is not an off-the-shelf item. For a start, it requires two things. The first is that a central bank needs a reasonable degree of independence, according to economic literature, to set and pursue its target. Even advanced central banks find themselves aligning with the economic agenda of the political class. So, no central bank is entirely independent of external influence. However, the degree of autonomy of a central bank is often measured by the freedom to choose the instruments to achieve the rate of inflation that the government deems appropriate for its desired speed of output growth. Where fiscal policy considerations dictate monetary policy, independence is hijacked.

Another important requirement is the willingness of a monetary authority not to target other indicators, such as wages, level of employment or the exchange rate, Sarwat Johan, an economic theorist, wrote.

Does the CBN fit the bills? During his confirmation, Cardoso assured Nigerians that he would protect the sanctity of CBN autonomy as prescribed by its enabling act. At the weekend again, he cited clauses of the act and assured that he is “irrevocably committed” to protecting the rules. As for the second requirement, it requires the discipline to choose and the courage to stay the course.

In all cases and frameworks, the level of fiscal indiscipline is an error term that could distort inflation control measures. In Nigeria’s case, it is an area where the fiscal authority would necessarily collaborate with the monetary authority to help it achieve not only price but also exchange rate stability.

Indeed, Nigeria’s monetary policy thrust is in its throes. But that is not to say Nigeria has not experimented with inflation targeting. During Sanusi Lamido Sanusi’s tenure at the apex bank, Nigeria was committed to an inflation band of six to nine per cent but not as an explicit policy direction. At headline inflation of over 27 per cent, a single inflation target may be unrealistic. But whatever target Cardoso and his team would settle for will suffice to raise the bar of public scrutiny and accountability.