Monetary Policy Management in Nigeria in the Context of Uncertainty

1. Monetary Policy Management in Nigeria in the Context of Uncertainty By Dr. O. A. Uchendu Ag. Director, Monetary Policy Department, Central Bank of Nigeria (CBN), Head office, Abuja

2. Outline of presentation • Introduction • Monetary Policy process • Nature of Uncertainty in monetary management in Nigeria • Dealing with Uncertainty • Conclusion

3. Introduction • Monetary management is an integral part of macroeconomic management • Task of monetary management is performed by the CBN on behalf of government • Monetary policy is the tool for Monetary management • It is the use of instruments at the disposal of the Central Bank to influence the availability and cost of credit/money in order to achieve macroeconomic stability • Stance/direction of monetary policy is dictated by the prevailing economic situation and Policy Objectives which have remained broadly the same over the years - Price stability; sound financial system, balance of payments viability and economic growth and development.

4. Introduction… • For most central banks the objective of price stability is given premium over others in the conduct of monetary policy • In many instances, however, the laws establishing the central bank imposes a dual mandate of low inflation and high growth • Monetary Policy effects are transmitted through a chain linking CBN actions to the economic goals/activity. • Macroeconomic aggregates such as output, employment and prices are in turn, affected by the stance of monetary policy via transmission channels: interest rate or money; credit; wealth or portfolio; expectations channel; and exchange ratechannels

5. Introduction… • Effectiveness depends on the level of development of financial system • A key challenge in monetary management is how to deal with uncertainty • Monetary policy must be forward looking and, thus, relies heavily on the outlook for key macroeconomic variables • Future is generally uncertain, and so is the overall environment of monetary management • From practical stand point, the monetary policy maker must identify the specific risks monetary management faces within the context of the economy in order to deal with those risks correctly

6. 2. Monetary Policy Process • Monetary policy process is fairly complex and involves: • setting objectives (primary focus of monetary policy) • choosing a nominal anchor (monetary policy strategy), • financial programming/model • monetary policy instruments and application • day-to-day conduct of monetary policy (routine activities include liquidity management, adjusting policy rate, communication) • Feedback, evaluation of outcomes, policy review • Activities are in practice intertwined, and are not necessarily sequenced as presented here

7. Monetary Policy Process… Setting Objectives • Objectives of monetary policy are well documented - price stability, high and sustainable output and employment, viable external sector, etc. • 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, hence the popularity of the dual mandate • Each of the goals is important in its own right. • The CBN is expected to conduct monetary policy in such a manner as to ensure price and output stability in the long run.

8. Monetary Policy Process… Nominal Anchor Generally, the two kinds of nominal anchor: quantity-based nominal anchor; and price-based nominal anchor. The quantity based nominal anchor targets money while the price-based nominal anchor targets exchange rate or interest rate. Currently, the CBN uses broad money supply (M2) as the nominal anchor for monetary policy. 8

9. Monetary Policy Process… Monetary Programme/Model In designing monetary policy the CBN….. reviews developments in the economy over a period, articulates the major pressures upon and risks to price stability; and formulates a framework which guides its monetary policy implementation. This framework is captured in a monetary programme At present the CBN uses the IMF financial programming framework which accounts for the four sector of the economy 9

10. Monetary Policy Process… Instruments Prior to the financial sector reforms of 1986, the CBN conducted monetary policy by direct control. The instruments of indirect monetary control include: credit ceilings; sectoral credit allocation; interest rate controls; moral suasion; special deposits issuance of stabilization securities; and exchange controls, etc. 10

11. Monetary Policy Process… Overtime and as a result of financial deepening and economy-wide macro-economic reforms that commenced mid 1980s, the CBN shifted to market-based instruments. Including: OMO Cash reserve requirements Discount window operations 11

12. Monetary Policy Process… Liquidity Management -Deposits of states government. Share of federation account allocation with the DMBs. -Emergence of increased capital private inflows. -Both structural and short-term excess liquidity have continued to pose a major monetary policy challenge. It relies on the daily assessment of the liquidity conditions in the banking system, so as to determine its liquidity needs and thus the volume of liquidity to allot or withdraw from the market. Liquidity management is supported by daily liquidity forecasting 12

13. Monetary Policy Process… Liquidity Management… Liquidity management involves the supply/ withdrawal from the market the amount of liquidity consistent with a desired level of short-term interest rates or reserve money. Main source of excess liquidity -monetisation of oil receipts and sharing of oil profits receipts -Government borrowing from CBN. 13

14. Monetary Policy Process… Routine M/P making: • Day-to-day conduct of monetary policy by the CBN relies on a theoretical framework which links the operating target (RM) to the intermediate 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 • Open market operations; changes in policy rate and reserve requirement, and communication are some of the important day-to-day actions • Feedback, evaluation of outcomes, policy review

15. 3. Uncertainty • For most developing countries, the key risks are the same due to the similarity of economic and social conditions • In Nigeria, monetary management confronts three kinds of uncertainty principally • Uncertainty about monetary and other data • Uncertainty about the transmission mechanism of monetary policy, and • Uncertainty about the fiscal policy outlook.

16. Uncertainty… • Data • Bulk of the data informing monetary management are monetary data which are typically subject to frequent revisions • Quality concerns are often high with other non-monetary data such as real sector statistics, many of which are infrequently available • Timing of availability of the real sector statistics less predictable.

17. Uncertainty… • Transmission Mechanism • Limited knowledge of the transmission mechanism of monetary policy is a common feature in developing countries • For Nigeria knowledge of the relative strengths of the transmission channels of monetary policy is still at the rudimentary level • Transmission mechanism of monetary policy is not fixed, i.e., changes over time • Monetary policy is formulated with some assumptions about the path (and/or strength of the path) through which policy impacts on the economy • Uncertainties add to complications of monetary management

18. Uncertainty… • Highly Uncertain fiscal environment • Fiscal policy matters a great deal for monetary policy • High possibility of fiscal shock in primary commodity dependent economies like Nigeria • Relatively strong fiscal freedom at the lower tiers means high risk of fiscal surprises • Fiscal surprises can undermine monetary management substantially • Risk is enshrined in the possibility of that monetary policy grossly underestimates or overestimates the magnitude of needed intervention.

19. 4. Dealing with Uncertainty • As a consequence the conduct of monetary policy by the CBN involves elements of risk management – • Process requires an understanding of the many sources of risk and uncertainty that the monetary policy policymakers face • Identifying key risks • Devising, in light of the risks, a strategy for policy aimed at increasing the likelihood of achieving the goals of policy - price stability and the maximum sustainable economic growth – over time.

20. Dealing with Uncertainty… • Data • Bank relies a lot on knowledge of the stable characteristics of certain variables (data) in forming opinion about the reliability of available data • Bank recently established a separate Statistics Department to liaise with the operational departments where monetary statistics are generated • Bank invests a lot in uplifting the capacity of her staff to manage data at different levels • Collaboration 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 • Automation of its key data generating processes - e-FASS, ERP and T24, to aid data collection, storage and retrieval .

21. Dealing with Uncertainty… • Transmission Mechanism and underlying macro relationships • CBN encourages and sponsors research and utilizes the outputs of those studies in making an opinion about monetary policy transmission on a continuous basis • Monetary policy makers at the Bank learn extensively Nigeria’s and other countries’ experiences in making assumptions about the transmission path of monetary policy • Over time experiences are formalized through independent as well as Bank-led studies and knowledge sharing • Development of institutional memory- Efforts in this direction has received a boost in recent years as part of the internal reform initiatives of the Bank

22. Dealing with Uncertainty… • Dealing with fiscal policy uncertainty • Bank’s major strategy continues to be to seek closer and more effective coordination with the fiscal authorities to obtain early signals • FLAC • Involvement of the Ministry of Finance in monetary policy formulation • MPC factors into the decision process, staff analysis and projections of fiscal variables based such developments as the international oil prices, government budget and past fiscal behaviors

23. 5. Conclusions • Uncertainty remains a major challenge for monetary policy not only in Nigeria but every where else. • Central banks generally continue to seek better ways of dealing with them. • Major approaches are research and close monitoring of key sources of uncertainty like data generating institutions and the treasury. • Judgment is key in monetary policy management