CBN and inflation management

INFLATION is dangerous and cancerous, and it is something every central bank and responsible government should worry about and strive to manage and keep within reasonable and acceptable limits for the benefit of the economy and standard of living of the people. Inflation hurts our buying power and makes it difficult for people to afford basic necessities of life. It raises the effective tax people pay on income they earn, which in turn discourages savings and investment, even as it also affects our retirement.
As noted by experts, inflation can distort an economy, drive out foreign investors due to exchange rate fluctuations, and topple governments especially when it becomes galloping or hyperinflation (double-digit inflation). With galloping inflation, prices rise 10 per cent or more in a year while hyperinflation renders a currency useless. As one writer puts it: ‘’In the event of hyperinflation, one will need a wheelbarrow filled with money to buy a loaf of bread as was the case in Zimbabwe in the 2000s and Germany in the 1920s.’’
The Central Bank of Nigeria, CBN, headquarters, Abuja
Inflation can be cost-push or demand-pull. The former arises due to higher production cost which leads to a decrease in aggregate supply and an increase in the overall price level, and the latter is when demand for goods and services in an economy rises more rapidly than an economy’s productive capacity.
Central banks manage inflation by controlling the quantum of money inflow into the economy, the volume of money in a system affects the GDP, overall growth, interest rate and unemployment, thus, the need for the right quantity of money to circulate to keep the economy healthy.
Some of the methodologies used by central banks to manage inflation include the Open Market Operation, OMO, which involves buying or selling of government securities which has been noted to be quite effective, easy to apply and flexible. Other methodologies are Bank rate, Credit ceiling, Special deposit, Funding, Cash Reserve Ratio and others.
The Central Bank of Nigeria(CBN), is working hard, and tactically so, to reduce inflation rate to a comfortable limit to ensure a better standard of living through a combination strategy of tight monetary policy and a strident effort to boost the productive capacity of the economy through innovative policies aimed at increasing local production and decreasing imports.
The strategy makes sense, because experts have noted that in the long run, it is the growth of a country’s supply-side productive potential that gives an economy the energy to grow without suffering from acceleration in cost and price inflation. But, in managing inflation, one should take note of the correlation between inflation and inflation expectation. The latter is the action people take to protect themselves when they begin to anticipate a decline in the purchasing power of their currency.
Inflation expectation creates an adverse effect, it hinders economic performance as people consume resources that would have been used more productively- they begin to spend more now than later and, in the process, heat up the economy which leads to spiral inflation and which can go out of control. In some economies, relevant institutions scrutinise certain indicators to figure out how the economy and inflation will perform in future.
The European Commission conducts a poll every month to seek consumer inflation development in the Euro areas, getting their perceptions of current inflation development and their expectation for the next 12 months. But the bottom line is that keeping inflation low and stable is an antidote for anchoring inflation expectation; and also to reinforce commitment to price stability in addition to clear communication.
Some market watchers believe that CBN is being tactical with a tight monetary policy which has witnessed the MPR standing at 14 per cent for a prolonged period, and that predictably, the apex bank would drop the rate, after the first half of 2018 when inflation rate would have dropped to a single digit.
But, the former Managing Director/Chief Executive Officer, Asset Management Corporation of Nigeria, AMCON, Chike-Obi, proffers an expansionary monetary policy now to spur growth. In a press report, Chike-Obi, an advocate of easy money, noted that ‘’interest rates are too high. So, what we have chosen is to defend the naira and inflation. For me, MPR should be at five per cent and we should be lending at eight per cent to businesses. My position is that we should expand, grow and be aggressive about it.”
But, historical research show that CBN’s tight monetary policy may be the best in the face of the current inflation headwind. The apex bank’s policy stance aligns with Milton Friedman’s advice, which contradicts Chike-Obi’s advocacy. Friedman had warned economists and policymakers not to try to stimulate economic growth at the cost of ‘’just a little more’’ inflation. A 1976 Nobel Prize winner in economics and the world’s most influential monetarist, Friedman was an intellectual leader of the second generation of Chicago price theory who had advised both the late former Republican US President, Ronald Reagan and the late former British Prime Minister, Mrs. Margaret Thatcher.
A survey of economists of the 20th Century ranked him as the second most popular economist after John Maynard Keynes. His advice and monetary theory influenced the Fed’s response to the global financial crisis of 2007-2008, his works include Price Theory Monetarism, Helicopter Money, Permanent Income Hypothesis, Applied Economics and Floating Exchange Rate, among others, and he is noted to have mentored several students and young professors who went on to become leading economists.
Also, CBN’s monetary policy align with that of the Fed under Paul Volcker (1979-1987)- ‘’the man who quashed inflation.’’ Before his appointment as Chairman of the Fed, prices were rising at 9 per cent and 11 per cent, which was debilitating considering that Fed funds rate are often kept within the band of 2 and 5 per cent, known as the ‘sweet spot’, to maintain a healthy economy.
Reportedly, Volcker launched a ‘wild fight’ against inflation. He announced that he would tightly restrict the amount of money in circulation and pushed interest rate up so high it threw the country into a deep recession, but it was noted he did it on purpose. Thereafter, things got worse, inflation spiked from 12 per cent to 14 per cent, but Volcker stuck to his gun. By 1981, inflation dropped to nine per cent and progressively to six per cent and further to four per cent. And Volcker became a hero.
CBN has consistently retained the MPR at 14 per cent, and inflation rate has continued to drop. From a high of 19.0 per cent in January 2017, it dropped to 17.78 per cent in February 2017, and further to 15.37 per cent in December 2017 from 15.90 per cent in November 2017. It dropped to 14.33 per cent in February, 2018 and further to 13.34 per cent in March, reported to be the sharpest decline in 11 months.
CBN Governor, Godwin Emefiele has predicted a single-digit inflation (less than 10 per cent) in July 2018. It will be recalled that he also predicted that the economy would exit recession in the second half of 2017, and it came to pass.


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