Inflation, interest rates, and the CBN’s options, By Uddin Ifeanyi

Very few patients with a life-threatening ailment would substitute the likelihood of death for the short-term inconvenience of a proven therapy. None would settle for the ravages of a cancer because the course of chemotherapy required to treat the cancer induces nausea and results in hair loss. That said, if the main arguments in the country today against the Central Bank of Nigeria’s (CBN) tightening of domestic monetary conditions in its fight to bring inflation down offers anything to go by, Nigerians clearly do not fall into the category of rational patients.

Long on hope and short on facts, the default argument has been that the CBN’s policies have failed abysmally. Part of the expectations of those persuaded by this position, it would seem, was that the apex bank needed only to raise its benchmark interest rate, once or twice, for inflation to have been laid low. Does it matter that this way of looking at things also refuses to see how domestic prices have been boosted of late by three distinct shocks; and how these (especially the increases in the pump price of petrol) compounds the apex bank’s task?

More significant, though, is the fact that an argument on how an economy should work is not familiar with, or perhaps chooses to ignore (probably off the favoured notion of Nigeria’s exceptional status), any of the theories around how economies work. There is a lag between when a central bank begins to tighten monetary conditions and when retail money market rates move up. This is both a function of how well the money transmission mechanism works and how money market instruments are structured. Long-tailed mortgages, for instance, would not immediately reflect increases in the central bank’s policy rate. Then, there is a lag between when retail rates go up and when the economy (and the inflation rate by extension) begins to slow down as a result. This again is a function of how an economy is structured.

Still, with the same 100 big name businesses in the country accounting for about 80 per cent of bank lending, opponents of the CBN’s current policy course could argue that the effect of tighter monetary conditions on retail prices was always going to be muted by the limited pass through from this narrow cohort of bank borrowers. (By the way, concentrated bank lending is a stronger argument for root-and-branch reforms to the stock market to make equity the go-to source of funding for Nigerian startups). If the rise in currency-in-circulation bears on domestic prices at all, then one could also argue that a rebalancing from currency-in-circulation to vault cash is critical to the task of slowing the economy to rein inflation in. The problem is that this goal is scarcely served by the current cap on deposit rates at the bottom of the savings pyramid. Toss in the CBN’s still translucent implementation of its cash reserve ratio policy and both the central bank’s signalling and the rails through which these signals reach the market are still a work in progress.

The example of the US’ fight against inflation, however, underlines why the anchoring of inflation expectations is critical to effective central banking. The task here is to ensure that the long-term inflation expectations of the populace do not stray too far from the central bank’s inflation target — especially in the teeth of temporary demand or supply shocks that push inflation below or above the monetary authority’s target. That this condition requires domestic economic entities to trust the central bank is without question. And yet in the US, it took all of four years of policy tightening before the Federal Reserve could drive inflation down to the rates we see today.

Even if we agree, then, that the horizon over which sections of the domestic commentary box are judging the efficacy of the CBN’s current policy tightening is too short, we cannot ignore the follow-through from recognising the limited utility of bank lending as a boost to domestic economic activity. For the fact is that inflation, not rising interest rates, was why major multinationals started downsizing/shutting down their operations in the country last year. Inflation is the reason Nigerians are poorer, today, and not rising interest rates. Inflation, not interest rates, is the reason Nigerians will not hold naira-denominated assets — indeed, were we able to achieve it immediately, positive interest rates would provide the strongest incentive for Nigerians to invert the structures of their portfolios: going long on naira and short on dollars. With domestic inflationary pressures still northward bound, the CBN’s non-accommodative monetary posture has a long way to go.

Is there a corresponding argument for bringing costs down generally across the country? A massive one, yes. But this is a fiscal policy dialogue. Not a monetary policy one. If somehow, we can find ways to boost domestic productivity, we would very easily boost government income at the same time. So, the tax reform being proposed by the federal government makes sense only to the degree that it brings costs to domestic economic entities down, not by how much it boosts the three tiers of government’s internally generated revenues.

Uddin Ifeanyi, journalist manqué and retired civil servant, can be reached @IfeanyiUddin.