Imagine you were a captain caught in a storm on the high seas. You have with you a copy of the approved guide for safely steering a ship through a storm but you also have with you a crew of well-regarded sailors who don’t think too highly of the guide and propose a different and unconventional method. However, you have wealthy passengers in your cabin who are depending on you and will much rather have you go with the guide. Your instincts tell you that the most important factor for your survival is the severity of the storm and that the steering does not have as much effect as everyone else thinks. What would you do?
Okay, the scenario above does not adequately cover the complexity of the situations that Dr Henry Wampah, the Governor of the Bank of Ghana (BoG) and Godwin Emefiele, the Governor of the Central Bank of Nigeria (CBN), find themselves in. But it is a rough illustration.
In response to a rise in inflation, Wampah chose the textbook monetarist response of hiking interest rates and increasing the reserve requirements of banks in a bid to reduce the money supply. The purpose of that approach is to reduce banks’ ability to lend and keep prices down because people would not have much money to spend.
Not only did he do that, he also hiked in anticipation of upward adjustments in utility tariffs. From 16% in November 2013, the policy rate has risen to 26%, a remarkable jump by all standards. Inflation has gone from 13.2% to 18.5% since that period but Wampah will argue that the depreciation of the cedi by 72% (against the US dollar), the 59.2 percent increase in water tariffs and the hiking of electricity tariffs by 67.2% as well as upward adjustments in fuel prices mean that inflation would’ve been much higher if not for the tight monetary policy he has adopted. The tightening has contributed to growth slowing to 3.6% in the third quarter of 2015, down from 7.6% in 2013.
Wampah has chosen to stick to the guide despite the complaints by well-regarded economists and business people that his hiking of the rates was rather causing the inflation by driving up borrowing costs.
The wealthy passengers in this case are foreign investors and the IMF, who have praised the monetary policy and have called for the BoG to continue hiking if inflation continues to rise.
Mr Emefiele on the other hand appeared, until recently, to have thrown away the guide and is determined to steer the Nigerian economy through the storm with unconventional methods. He came into office in June 2014 with inflation under 8.5% and an interest rate at 13%. Faced with the storm of low growth from the collapse in oil prices, Emefiele had to decide between tackling the growth or the inflation which was slowly creeping up.
In such a situation the guide would have required Emefiele to at least maintain the policy rate if he decided growth was too important to hike the rate to tackle inflation. Instead he surprised several mainstream economists by cutting interest rates to 11% and reducing the cash reserve requirement of the banks to 20% from 25%. His reason for this move was that he had tasked banks to lend to infrastructure projects, agriculture and mining in order to generate employment.
This surprise move should have sent the naira’s value plunging but it did not. In fact, the currency did not move a bit. How is that? Well Emefiele had pegged the naira at 197 naira to 1 US dollar and had set up a whole bunch of rules to restrict access to foreign currency. This has made the black market lucrative with the dollar trading for as high as 320 naira but as far as Emefiele is concerned, the naira remains stable.
In his recently published memoir the former Chairman of the Federal Reserve, Ben Bernanke, says
..monetary policy is 98 percent talk and 2 percent action.
This quote is relevant because it shows how little the actual policy of a central bank can do and how much the words of a central banker can do. It is of the utmost importance that a central bank does not lose credibility. When it does, then its policy tools become weaker because people cannot expect it to act predictably.
I took this little detour because the CBN governor, after signalling that he was pursuing growth by loosening monetary policy made a sharp reversal by raising interest rates to 12% and increasing the cash reserve requirements of banks to 22.5%. This was after Nigeria’s inflation rate jumped to 11.4% in February from 9.6% in January. What exactly did Emefiele expect would happen when he loosened monetary policy under those conditions? Why retreat at the first sign of inflation?
Let’s go back to the ship. Captain Wampah is sticking to the guide, no matter what happens in the short term, he is confident that he will steer the ship safely until the storm ends. Communication is important. Whether he’s steering it rightly or wrongly, people can be certain about his moves. They can predict and plan accordingly. Captain Emefiele chucked the guide and decided to try bold and unconventional methods. But when a predictable consequence of his steering style occurs, he quickly picks the guide and returns to what it says. Without even giving much of a chance for his policy to work, he has returned to the textbook. (Well not fully, because he still maintains the currency peg.) But the impact is that his passengers are uncertain, they can’t predict so they can’t plan and they lose confidence in their captain.
Perhaps, the difference in policy style between Wampah and Emefiele is a reflection of their backgrounds. Wampah has been working at BoG since 1986. Emefiele was MD of Zenith Bank before his appointment. One is an economist who earned his stripes through contributing to monetary policy. The other is a banker who earned his by managing a large bank across several countries. It is no surprise that one is more likely to follow convention than the other.
To be clear I am not passing judgement on the effectiveness of their policies, that is another debate. However I am assessing their conduct with regards to maintaining policy credibility, which is crucial. And in that, Emefiele has fallen short.
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