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35 Is Monetary Policy the Best Instrument for Inflation Journal of Business and Organizational Development Volume 3, December 2011 © 2011 Cenresin Publications www.cenresinpub.org IS MONETARY POLICY THE BEST INSTRUMENT FOR INFLATION TARGETING IN THE NIGERIAN ECONOMY? Job Pristine Migap Department of Economics Kwararafa University, Wukari E-mail: [email protected] ABSTRACT Since the debasement of money emerged, particularly during the 17th and 18th centuries when precious metals were still being used as coins in continental Europe & North America, whereby governments and monarchs often combined gold coins with other metals such as silver, copper or lead and reissue them at the same nominal value, the intrinsic value attached to each metallic coin declined. Consumers who used them had to pay higher prices (more coins) for the same quantity of goods and services than was the case in the past. Price inflation was therefore, a fall-out of monetary inflation. It is in this context that price inflation is essentially considered as a monetary phenomenon. But, does it mean that inflation can only be controlled through monetary policy? This paper, answer in the negative. Reviewing literature on conceptual and empirical issues on monetary policy, inflation, and fiscal policy; this paper posits that inflation in Nigeria though a monetary phenomena is essentially supply oriented in nature and can best be controlled by fiscal policy measures. It therefore suggests that government should put in place the necessary infrastructures that would lower the cost of production (supply side-economics) in the economy and enhance output thereby achieving its inflation targeting regime. Keywords: Price Inflation, Monetary Inflation, Monetary Policy, Fiscal Policy, Inflation, Inflation Targeting, Economy, Nigeria, Supply Side-Economics. INTRODUCTION Inflation refers to the persistent and sustained rise in the general level of prices of goods and services in an economy, manifesting visibly in the decline in the value of money. The effects of high inflation on the economy are generally considered to be predominantly harmful. That is why the achievement of price stability has always been one of the fundamental objectives of macroeconomic policy in both developed and less developed countries (Orubu, 2009). In Nigeria, inflationary pressures reflecting in persistently rising prices have been an issue of concern to the authorities since the late 1960s.Thus,through the 1970s and well into the first quinquennium of the 1980s,anti-inflation policy became a regular feature of governments’ overall economic policy agenda. Inflationary pressures heightened substantially after the adoption of the Structural Adjustment Programme(SAP) in 1986,with the inflation rate rising as high as 38% and 49% in 1988 and 1989 respectively. Despite a mild respite in 1990 with a single digit rate of 7.5%, the inflation rate climbed up steadily to about 44.9% in 1992, and up as high as about 72.8% in 1995.In its effort to stem the problem of inflation in Nigeria, the policy authorities have over the years used a combination of several measures, ranging from wage freezes, price controls, direct involvement of government in the procurement and distribution of essential commodities, to fiscal and monetary strategies. Since the late 1990s 35 Is monetary Policy the Best Instrument for Inflation targeting Job Pristine Migap in the Nigerian Economy? the Central Bank of Nigeria (CBN), has however focused more on monetary strategies to combat inflation (Orubu, 2009). A new monetary policy strategy “Inflation Targeting”, pioneered in New Zealand in 1990 is however now gaining popularity in both developed and developing countries. Inflation targeting is an operational framework for monetary policy in which the attainment of price stability becomes the overriding concern of the central bank (Oluba, 2008). The Central Bank of Nigeria (CBN) commenced the implementation of Inflation Targeting (IT) regime as one of its core Monetary Policy strategy, using the Monetary Policy Rate (MPR) as the main tool of stabilization in 2009.There are various causes of inflation and the appropriate measures that can be taken to control or curb it depends on the peculiarities of the individual economy concerned. The crucial issues are: Is the Nigerian inflation phenomena demand oriented as to always warrant using monetary tools? Or is it supply oriented? Which is best handled with a combination of fiscal tools and supply-side economics; (an appropriate instrument for developing economies with shallow financial markets) considering the enormous role that government incomes and expenditures has in such economies? Is monetary policy as an instrument of economic stabilization well entrenched within the Nigerian economy as to always ensure its effective utilization as a policy for inflation targeting? This paper attempts to answer these questions, and is organized into five sections. Following the introductory section is section two, which provides an overview of conceptual issues in monetary policy and inflation. Inflation targeting: concepts and applications are reviewed in section three. The desirability of fiscal policy/supply side economics as long term means of controlling inflation targets are thoroughly discussed in section four. While section five, is concluding remarks. MONETARY POLICY Monetary policy is the process by which the government, central bank, or monetary authority of a country controls the supply of money, availability of money and cost of money or rate of interest to attain a set of objectives oriented towards the growth and stability of the economy. There are several monetary policy tools available to achieve these ends: increasing interest rate by fiat; reducing the monetary base; and increasing reserve requirements. All have the effect of contracting the money supply; and if reversed, expand the money supply (Wikipedia, 2009).The primary tool of monetary policy is Open Market Operations(OMO).This entails managing the quantity of money in circulation through the buying and selling of various financial instruments, such as treasury bills, company bonds, or foreign currencies. All of these purchases or sales results in more or less base currency entering or leaving market circulation. Usually, the short term goal of open market operations is to achieve a specific short term interest rate target. In other instances, monetary policy might entail the targeting of a specific exchange rate relative to some foreign currency or to gold. For example, in the case of the USA the Federal Reserve targets the “Federal Funds Rate”, the rate at which member banks lend to one another overnight; however, the monetary policy of China is to target the “Exchange Rate” between the Chinese renminbi and a basket of foreign currencies. Other primary means of conducting monetary policy include: Discount Window Lending (lender of last resort): discount window lending is where the commercial banks, and other depository institutions, are able to borrow reserves 36 Journal of Business and Organizational Development Volume 3, December 2011 from the central bank at a discount rate. This rate is usually set below short term market rates(Treasury Bills).This enables the institutions to vary credit conditions(i.e., the amount t of money they have to loan out),thereby affecting the money supply. It is of note that the discount window is the only instrument which the central banks do not have total control over. Fractional deposit lending (changes in the reserve requirement); the monetary authority exerts control over banks. Monetary policy can be implemented by changing the proportion of total assets that banks must hold in reserve with the central bank. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. By changing the proportion of total assets to be held as liquid cash, the Federal Reserve changes the availability of loanable funds. This act as a change in the money supply. Central banks typically do not change the reserve requirement often because it creates very volatile changes in the money supply due to the lending multiplier. Moral suasion(cajoling certain market players to achieve specified outcomes):this is a situation where the monetary authority through regular dialogue and consultations with banks and other financial institutions on the platform of Bankers Committee and other channels in order to encourage enhanced efficiency in the financial system.es[specially with respect to interest rate management. “Open Mouth Operations”(talking monetary policy with the market) INFLATION Given the definition of inflation as the persistent increase in the price level, or a persistent decline in the purchasing power of money, and that this is caused by an increase in available currency and credit beyond the proportion of goods and services, it follows that the core concept was originally that of monetary inflation. Price inflation, which is a common usage of the concept, is therefore as a result of monetary inflation(Mcmahon,2008).Price and output in an economy reflect consumer tastes and production conditions at any point in time. Supposing the conditions which prevail in the current period are such that the supply of certain goods is above the normal level, prices of such goods will have to fall before consumers on the average will be willing to absorb the excess supply. Now, since every economy faces a resource constraint, the production of goods can only occur at
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