Mahmud: Why Central Banks Must Deal with Inflation Decisively

Dr. Hassan Mahmud is the Director, Monetary Policy Department of the Central Bank of Nigeria. In this interview on the sidelines of a recent retreat organised to appraise the apex bank’s monetary policy framework, he talks about the relevance of inflation targeting following the increasing level of uncertainties across the world. Obinna Chima brings the excerpts:

What was the essence of this retreat?

The Monetary Policy Department 2022/2023 annual retreat its theme was centred around appraising our current monetary policy framework, which is what is called monetary targeting framework. Under this we look at monetary aggregates, which includes things like money supply; base money; M3, which includes open market operations (OMO) and other monetary liquidity instruments within the banking system. And we use the volume of that to adjust that volume, so that what we call short term rates would adjust to feed into the banking system rates and by extension, the interest we have within the economy. We also use the volume of that liquidity, using monetary tools to either release liquidity or mop up liquidity so that we can keep general price levels at a particular target that we have. So, we use those volumes to do that. But you will understand that we have been having some not-to-efficient outcomes in the sense that as we keep mopping up, as we keep tightening, loosening, increasing cash reserve requirement (CRR) and monetary policy rate (MPR), we still see the economy awash with liquidity, either from currencies that are outside the banking system that are impacting on these prices (which includes interest rates, exchange rate and inflation rate). So, there are currencies that are outside the banking system that would impact on those rates that are not within the purview of the CBN and that makes monetary policy implementation less efficient or the outcome not optimal. So, the point is, are we at the stage where we would start looking at facing our core mandate, which is price stability and using inflation itself as a target, in terms of monetary aggregate? That is, we would look at inflation and target it explicitly. That is, we come out with a framework of the range of inflation we are looking at. Before we do that, we would have done our forecast and modelling and have a projection of where we should be, before announcing it to the public. The public would then be able to assess the central bank based on how it is able to stay within its target. So, with that, we would be looking at the inflation numbers and adjust other parameters to get to the inflation target, instead of looking at the monetary aggregates and then letting it feed into the prices. Globally, this has been the adopted monetary policy framework, particularly since after the 2008 global financial crisis. It is also a requirement within the Economic Community of West African States (ECOWAS) and African Union (AU) member countries central banks to also adopt inflation targeting. That is why during the retreat, we invited the Director of Research at the Central Bank of Kenya, because they are doing inflation targeting; Ghana is also doing inflation targeting and few others including South Africa, Botswana, which are also doing inflation targeting, to share their experiences. This recent crisis post COVID and the Russia-Ukraine war, have also seen how countries are able to manage inflation. Today, a lot of countries across the world are still struggling with inflation numbers and are still tightening, even in Nigeria.

You mentioned countries such as Ghana and others that are also doing inflation targeting, but surprisingly Ghana’s inflation is still on the high side and how will the decision reached at the retreat affect your decision to ease and tighten liquidity in the market?

The easing and tightening will still continue because liquidity still matters. Even under inflation targeting we would still continue to do what is called monetary programming. What is key here is: I said before that our target is monetary aggregates, so we are looking at the volume of money supply in the system (that is M1, M2, M3), but now we would be looking at inflation itself. We have done exchange rate targeting in the past, but now we would be looking at inflation itself. In terms of the question on Ghana, yes, the country has been adopting inflation targeting, but the crisis that engulfed Ghana was far beyond that space. They had currency crisis and exchange rate crisis, when they reduced four digits in their currency; they have banking system crisis which came in post-COVID and they are on the facility of the International Monetary Fund (IMF). But those are shocks that came into their economy and kind of collapsed the economy. There are countries that adopted inflation targeting for over 30 years and are also confronted with crisis. So, the economic dynamics does not mean because you are doing inflation targeting, you cannot have shocks. But domestically, you must have a focus and that focus is what you are looking at. You must also have resilience against these types of shocks. You see the United States having banking system crisis, with four bank failures in recent time.

But there was a time the CBN was doing inflation targeting?

We are presently doing what is called implicit inflation targeting, but not explicit. Internally, we said we want single-digit inflation and that came from the Ministry of Finance of government and we work towards that target. When you do inflation targeting, what is most critical is the central bank’s credibility. If you say you are going to be here, can you be there? So, before a central bank would say the range it is targeting, they would have done in-house modelling, simulation, scenario, etc. So, we do implicit inflation targeting, but we want to migrate to explicit inflation targeting. One factor that is also playing out in inflation phenomenon is what is called inflation expectations. The people already price what they think inflation should be and they put it in their prices. That builds up inflation. Those are the things we are looking at.

But do you think inflation targeting is still relevant considering the global headwinds?

It is extremely relevant. The point that is being made now is that central banks should focus on their primary mandate. Central banks went into so many things, particularly in economies that are not well developed, just as we saw with the CBN and many other central banks in developing countries. But these crises that came in following the COVID-19 has made it clear that central banks must deal with inflation decisively. It is also part of the convergence criteria requirements that all ECOWAS countries must adopt inflation targeting. It is like we are conforming with the global best practices and also with an understanding of the situation in our environment. We are just trying to see how we can better implement monetary policy for optimal outcomes. All along we have been saying the factors driving inflation are structural, but recently, particularly post-COVID injections, we have seen that the huge monetary injections have now translated to being monetary phenomenon in our inflation numbers. There is too much money and the output is not coming to that level. So, there is demand pull inflation and that is why recent tightening all over the world is to shrink aggregate demand, reduce the capacity of credit growth and also spending, so that the supply side can meet up and then you start seeing equilibrium.