By Professor Emmanuel Ating Onwioduokit.
I am delighted at the opportunity to speak at the First National Economic Forum organized by the Nigerian Christian Graduate Fellowship. The theme of this Forum is very apt, given the current state of our national economy. The key economic policy priorities for normal countries when an economy is in a recession is usually how to deploy every available policy tools to ensure that the growth of the economy is re-established. To foster economic growth even in normal times, requires both accurate diagnosis of the factors determining or constraining growth performance as well as suitable macroeconomic policy prescriptions regarding the structural reforms needed to achieve higher and sustainable growth.
Again, when I got the invitation to participate in this discussion, the first thing that came to mind was that the convener must be expecting something other than a discussion on the objectives of monetary policy (in terms of medium-term focus versus fine-tuning; and short-term versus long-term effects of monetary policy on output). However, it is next-to-impossible to avoid starting from the objective of policy. At one level, the reason is that it is a truism, I think knowing what to do is made significantly easier by knowing why you want to do it. There may be exceptions to this rule, nevertheless economic policy is surely not one of them.
At another level, one must start with the objectives of policy, because the very same monetary policy operations can occur in each situation even though the objectives of policy are quite different. The circumstances that generate the apparent similarity in behavior will not last, and the true motivations of the policy maker will be revealed. It is therefore imperative to be able to extricate the motivations of the monetary authorities – the reactions of the economy to a given monetary policy stance will differ depending on the public’s understanding of the underlying objectives of the policy maker. Indeed, if the public perception of the monetary policy objective is mistaken, unnecessary economic costs will ensue.
Today, I will discuss what the contribution of monetary policy to economic growth especially during recession should be. This is an issue that has long been the subject of theoretical and empirical debates among economists. Currently, with negative growth and given actual or perceived constraints on economic policies, the debate has become rather heated, and there has been numerous calls from politicians and academics for monetary policy to pay more attention to growth. However, before we proceed to examine a few fundamental issues concerning the role of monetary policy in fostering economic growth, it is pertinent to situate our discussion by first considering the concept of recession.
At any given point in time, every economy is located on a point on the business cycle trajectory. Business cycle denotes oscillations in production, trade, and general economic activities within a medium-to-long-term especially in a capitalist economic structure. The business cycle is essentially the mounting and downhill movements in gross domestic product (GDP). While the rising or upward movement is known as period of economic expansion, the reverse is term economic contractions.
Recession is characterized by across-the-board slowdown in economic activity for two successive quarters. Recession is usually characterized by deterioration in key macroeconomic indicators including, Gross Domestic Product (GDP), private investment, rate of employment, consumer spending, capacity utilization, business confidence, business income, and most times deflation. Theoretically, an economy is said to be in recession when it records two uninterrupted quarters of negative growth in real GDP.
Business cycle, as presented in Figure 1 is made up of periods of booms tracked by a period of recession, slump, and recovery. In the period of boom, there is high employment, high output growth rate and high level of consumption buoyed by consumer confidence, high private investment, improved standard of living, and high inflationary pressures. During this period, almost all macroeconomic indicators move upward. In a period of recession, economic activities slowed significantly, most macroeconomic indicator move downward. When the downward drift reaches the trough, it is referred to as depression. This is a situation where there is a protracted recession for a period of over eight consecutive quarters. As indicated in figure 1, a recovery phase is usually activated during recession by a plethora of fiscal policy measures that involve the use of taxes and massive government expenditure as well as monetary policy that include deliberate policy to ease the cost and availability of funds in a synchronized manner, aimed at stimulating economic activities. During the recovery phase, consumer confidence begins to rally and business investment surged gradually. Overall, most macroeconomic indicators start to nudge upward, resulting in increased production of goods.
FIGURE 1: BUSINESS CYCLE
Endogenous and exogenous factors usually cause recession. The endogenous causes often include regulatory sloppiness and/or policy irrationality. The exogenous causes of recession include external occurrence that is not because of domestic policy misapplication. These include things like crop failure, natural disaster, prolong unrest, and wars, which cause wide-ranging economic slowdown. Similarly, a country that depends on export of a few commodities is susceptible to frequent recession when there is adverse international price movement for its products.
As indicated earlier, the effects of recession are multifaceted: reduction in household incomes due to economic slowdown, which reduces the purchasing power and consequently reduce the demand for goods and services. Low demand from households causes firms to expurgate their production of such goods and services. This will lead to lower profit and staff lay off compounding the unemployment situation. The cycle will adversely impact on the stocks prices. Another consequence of recession is high rate of non-performing loans that affects the financial system ability to lend to the individuals and businesses.
The instrumentality of monetary and fiscal policies is usually deployed to counter recession to restore the economy to a recovery path.
Monetary authority usually pursues expansionary monetary policy to stimulate growth in times of recession. This involves lowering the cost of credit, which is usually realized by dropping policy rate, and reducing eligibility conditions for financial institutions to access the funds from the Central Banks. Such actions of the Monetary Authority are expected to inspire persons and industries to easily access funds for consumption and expansion of the production base. With increased consumption, industries hire more employees and purchase more raw materials for production, thereby, stimulating economic activities. Other options available to monetary authority is quantitative easing. This is the process whereby, monetary authorities inject money into the banking system to shore up banks’ balance sheet and/or by purchasing government securities from the secondary market, thus, injecting money into the economy to stimulate growth.
Fiscal authorities pursue expansionary fiscal policy to pull the economy out of recession. Government can lower taxes on persons and industries thus releasing additional resources to these units for consumption and investment. Additional instrument and indeed the most potent is to increase government spending in real- economic activities during recession to restore the economy to the desired growth path. If consumption rises, businesses will engage more factors of production which will create more employment eventually stimulate economic growth.
There are four questions that I believe when we answer correctly will aid our understanding of the role of monetary policy during recession: can monetary policy contribute directly to the attainment of a high and sustainable rate of growth to lift the country out of recession; can monetary policy promote economic growth indirectly by maintaining an environment of price stability; can monetary policy effectively influence the pace of growth in the short and medium term and thus help stabilize output fluctuations consistent with its overriding objective of price stability; and what is the role of the other policies in fostering sustainable economic growth in Nigeria.
To accomplish this task the rest of the paper is organized into four parts. Part II dwells on monetary policy and long term economic growth, while Part III discusses economic fluctuation and monetary policy. Part IV examines the needed economic reforms to enhance sustainable growth in Nigeria. Part V contains some concluding remarks.
II. Monetary Policy and Long-Term Economic Growth
Monetary policy is the process by which the Central Bank or monetary authority of a country, seeks to influence the availability and cost of money in the economy to attain a set of objectives, which include growth and price stability. Monetary policy is either expansionary or contractionary. Expansionary policies increase the quantity of the money supply, or decrease the interest rate, while contractionary policy reduces the quantity of the money supply or raises the interest rate.
Ideally, in examining the effects of monetary policy on economic activity and growth, it is useful, both for conceptual and for policy details, to distinguish between long-term and short-term effects or, alternatively, between permanent and transitory effects. A crucial issue in monetary theory is whether changes in the stock of money or in the rate of growth of money can have permanent effects on real economic variables. In particular- the interrogation concerning the so-called super neutrality of money – whether a permanent change in money growth has no long-term effects on the real interest rate, capital accumulation and output growth – has been the subject of extensive theoretical enquiry over the past fifty decades.
There are two very diverse theories which explicate the path of causality. The first, monetary-business-cycle theory clarifies that changes in growth of the money supply cause changes in output growth: money causes output. Representations in this category are identified as new Keynesian models or sticky-wage models, which consider wage contracts as a central feature of the economy. Individuals sign long-term wage contracts that fix their money wage over the length of the contract. If money supply increases at a quicker rate than it was projected at the time of the contract negotiation, inflation will be higher than expected, so individuals’ real wage will decline. This, in turn, influences firms’ behavior and they demand for more workers, which leads to an increase in the economy’s output. Thus, the sticky-wage theory with unanticipated changes in money describes a positive relationship between money growth and output growth (Tobin, 1965; Fisher, 1977; Taylor, 1980).
Alternative explanation by monetary-business-cycle theorists for non-neutrality of money stems from a class of models recognized as imperfect information models (Lucas, 1975; Barro, 1976). These models explain that monetary changes can have real effects because individuals have limited information and thus may misperceive aggregate and relative changes. Put differently, in these representations, if the money supply increases, prices will tend to rise throughout the economy but individuals attribute part of the price increase to a shift in demand toward their own product and away from the goods produced by other sectors. This implies that an increase in the relative demand because of the misperception leads to a rise in production.
The second, real-business-cycle theory, differs primarily in the direction of causation between money growth and output growth. Real business-cycle-models assign a causal role to real economic activity in affecting money supply. That is, changes in output growth cause changes in growth of the money, not vice versa. Shocks can affect supplies of real resources and relative prices that individuals expect to face over time. These shocks include technological innovations, other sources of productivity changes, environmental conditions, the world price of energy, developments in the labour market, and government spending and taxes. Thus, in real business-cycle-theory, real shocks determine output growth, not by money growth (Kydland and Prescott, 1982; Long and Plosser, 1983).
In real-business-cycle-models, money is related to output because it reacts to the same real shocks that output responds to. The advocates of real-business-cycle models offer two reasons why money reacts to real shocks. The first reason rests on the idea that developments in the real sectors of the economy influence individuals’ financial decisions. This, in turn, affects the quantity of money demanded. So long as the financial system reacts to the changes in money demand, changes in output growth create changes in money growth. This implies that output causes money, not vice versa.
The second reason stems from the assumption that individuals have information about economic activity that cannot be quantified. For example, higher expected output might create a rise in the demand for money and credit. Policymakers will permit the money supply increase to accommodate the rise in money demand so that interest rate does not change. This implies that there is a unidirectional causality between output growth and money growth, running from output to money supply.
On the empirical front, money-output relationship has been documented cursory and rigorous empirical studies employing a range of data sets. Urbane empirical models have been developed to study the implication of anticipated and unanticipated (Barro, 1977), positive and negative (Cover, 1992; Thoma, 1994). Whereas some studies found support for unidirectional causality, running from money to income (Sims 1972; Devan and Rangazar, 1987), other studies including Cuddington (1981) and King and Plosser (1984) have provided evidence on unidirectional causality, running from output to money.
Again, as noted by Hayo (1999), there are empirical evidences of bi-directional causality between money and output for several countries. However, the existing empirical evidence based on testing of causality between money growth and output growth, is at best, mixed and uneven (Ahmad, 1993; Hayo, 1999).
The inconsistency of results in Granger causality test simply twigs from the form the variable entered the models: whether the variables are modelled as (log-) level variables or growth rates (Christiano and Ljungquist, 1988); or whether they are modeled as trend- or difference stationary (Hafer and Kutan, 1997).
Christiano and Ljungquist (1988) argued for level variables, since they find that power of the tests on growth variables is very low. Hafer and Kutan (1997) emphasized that the variables, which are assumed to be trend stationary, money Granger causes output and if the variables are assumed to be difference stationary, output Granger causes money. While there has been much of empirical work on the linkages between money and economic activity in industralised countries, there have been few analyses for developing countries. These analyses include Onwioduokit (2013), Judson and Orphanides (1996), Ghosh and Phillips (1998), Khan and Senhadji (2001), and Onwioduokit and Apo (2006).
The general conclusion that could be drawn from this review of the money, and output growth literature is that the weight of evidence does not support the notion that monetary policy makers could sustainably raise growth by tolerating higher inflation. On the contrary, theoretical analyses (regarding the real effects and welfare costs of inflation) as well as most of, empirical evidence strongly suggest that price stability is conducive to long-term growth.
III. RECESSION IN NIGERIA: MONETARY POLICY RESPONSE
Signs of looming recession emerged in Nigeria in the first quarter of 2016, when key macroeconomic indicators showed sharp declines: GDP recorded 0.36 per cent contraction, various sectors (manufacturing, real estate, financial services, and petroleum), of the economy experienced analogous trend. Oil revenues, plummeted to about 40 per cent of consolidated government revenues against about 70.0 per cent prior to the period, because of the decline of oil prices. This weakened government’s balance sheet, lurched current account deficit to an estimated 2.4 per cent of GDP. The precarious situation was exacerbated by the destruction of oil installations by Niger Delta militants. Crude oil production dropped to its lowest level in 25 years (with production volume of 1.1 million barrels per day). Nigeria’s total exports dropped by over 44.0 per cent. Against a background of a country that was acknowledged as the largest economy on the African continent only a two years earlier. The continued reliance on oil for Nigeria’s budget revenue is at the pivot of the nation’s susceptibility to the vagaries of shocks in the international oil market.
The corkscrew effect of low crude oil prices is widespread and deep in a unitary State that masquerades as a federation. Given the inbuild inefficient in the Nigeria’s constitution that make other federating units at best appendices of the centre; with the fiscal shock, over 28 state governments were either unable to pay or were late in paying workers’ salaries. Contractors were owed across the country. This disseminated the purchasing power of the citizenry and business. The removal of fuel subsidy led to increase in transportation costs. Also, investors’ confidence was at the lowest ebb, as the Government’s indiscreet pronouncement at home and abroad effectively scared Foreign Investor away from Nigeria.
The Nigerian economy was officially in recession from second quarter of 2016. The economy contracted by 1.30 per cent in Q4 2016. Generally, the economy contracted by 1.51 per cent, in 2016. The non-oil sector contracted by 0.33 per cent in Q4, mainly mirroring the slowdown in the agricultural sector, which decelerated to 4. 03 per cent in Q4 2016 from the 4.54 per cent recorded in Q3 2016.
Let me be upfront with you here, Nigeria’s recession was caused by the Government’s unguided, naïve, and uneducated grandiloquence and boorish perspectives to critical issues that it was obviously ignorant of how to confront. Thereby, finding solace in unconscionable propaganda. One of such uninformed position was public declaration of unwillingness to adopt a flexible exchange rate for the domestic currency which resulted in massive withdrawal of funds by foreign investors.
The instability made foreign investors to liquidate their investments and cut their losses, this resulted in unprecedented demand for the dollar. Given that in the process of trying to exit, foreign investors were keen to purchase dollars at whatever price, resulted in the unprecedented depreciation of the value of the domestic currency with the concomitant adverse implication for general price level and other key macroeconomic variables. The value of naira was held artificially for over eight months, during that period, the monetary authority was still trying to fully read and /or interpret the body language of the President before appropriate decisions would be taken. Evidently, some investors that did not participate in the first exodus, but decided to hedge against massive anticipated devaluation, by engaging in currency substitution were forced to join the fleeing investors, when the Central Bank of Nigeria adopted one of the most uneducated foreign exchange policies in Nigeria’s recent history by banning deposit of foreign currency into domiciliary accounts. To worsen the precarious situation, the Bank announced another despicable policy of rationing dollar to certain sectors and banning some sectors from participating in the foreign exchange market.
The results of these policy missteps are the prolonged recession we are experiencing currently. My conclusion is that monetary policy until very recently failed Nigeria, not so much because the authorities did not know what to do, but because ignorance was given a free reign to dictate. Making a strong case for strong institutions in Nigeria.
A key reason it might not be desirable for monetary policy to play a leading active stabilization role is that there is evidence that a large, if not the largest, part of cyclical output variability can be attributed to real, rather than nominal or demand shocks. Such real shocks, cannot be effectively offset by monetary policy.
Furthermore, in normal times when the central bank is confronted with cyclical fluctuations of average magnitude, the systematic pursuit of an activist counter-cyclical policy can be ineffective and may increase rather than moderate output volatility. The risk of this occurring arises because of uncertainty about the magnitude and timing of the effects of monetary policy on output. There are uncertainties associated with identifying the types of shocks and assessing the precise cyclical position of the economy. These considerations lead to the conclusion that the conduct of an activist, fine-tuning counter-cyclical monetary policy involves more risks than potential benefits and should be avoided in normal times.
Nevertheless, it is possible to envisage circumstances, triggered by severe shocks, like the current recession, when monetary policy can and should play an active role in stabilizing output around its potential growth path. Such a policy would have to be implemented carefully and consistently with the central bank’s commitment to its primary objective of maintaining price stability. It should also be communicated effectively so that public expectations and the central bank’s credibility would not be severely affected. The precise nature of the policy reaction will, of course, depend on the nature of the shock as, for instance, the response to an adverse supply shock would be very different from the response to a demand shock.
The Central Bank of Nigeria’s mandate and strategy are fully consistent with the theoretical arguments and the empirical evidence regarding the role and effectiveness of monetary policy in preserving price stability and fostering economic growth. A key element of the strategy is the commitment to maintain medium-term price stability, which is defined quantitatively as single digit inflation in Nigeria. The combination of commitment and flexibility that characterizes the Bank’s strategy allows for some “constrained discretion” in dealing with cyclical output fluctuations in a way consistent with the preservation of price stability.
IV. ECONOMIC REFORMS TO INCREASE SUSTAINABLE GROWTH IN NIGERIA
The broad conclusions that emerge about the contribution of monetary policy to economic growth are: monetary policy cannot be expected to raise growth sustainably in the long- run; and although monetary policy can play a stabilizing role over the medium term, the scope of such role might be constrained by the pursuit of the primary objective of price stability, the nature of the monetary policy transmission mechanism, including the vagueness facing policy makers and the stance of macroeconomic policies.
These conclusions raise dual relevant queries: How can we increase long-term economic growth in Nigeria and how can we speed up the recovery of the Nigerian economy towards its potential growth path?
During the five years preceding 2015, economic growth averaged a modest 6.3 per cent. At the same time, the pattern of inflation and interest rates during this period reflect the medium-term orientation of monetary policy. However, as noted earlier, external shocks arising from dramatic decline in the price of crude oil coupled with policy inertia and outright policy missteps by the Government to deal with emerging challenges from second quarter of 2015 through second quarter of 2016 resulted in the consistent quarter by quarter negative growth rate of the economy.
Although the preservation of price stability and the implementation of sound macroeconomic policies are required to foster sustained growth, structural reforms are essentially the main policy instrument for increasing long-term growth. Indeed, there are two complementary routes through which it is possible to advance trend economic growth.
The first is to remove obstacles to the efficient utilization of resources by improving the functioning of market mechanisms. For instance, by reforming labour market institutions, it should be possible to reduce structural unemployment. The resulting higher labour input should allow the level of output to increase, giving a temporary boost to economic growth until unemployment fall to a new lower, and sustainable level. The second route involves implementing policies that permanently raise economic growth. This requires knowledge of the factors that drive the growth process in Nigeria.
The policies required to increase long-term growth in Nigeria will therefore fall largely within the remit of national governments. The Broad Economic Policy of the Federal Government should:
o restructure the production base of the economy by devolving more economic powers to the states;
o revisit the revenue allocation formula by building in incentive and reward mechanism;
o facilitate investment in research and development and in infrastructure;
o enhance the role of small and medium- sized enterprises in research and development through their participation in integrated projects; and
o complete the internal market to help increase the competitiveness of industry, thereby fostering productivity and business dynamism.
More specifically, it should be emphasized that a fully integrated financial market would help to channel savings more efficiently into productive investment. The key issue is whether these reforms will be implemented in a timely and effective manner. Unfortunately, the implementation of previous reforms measures in Nigeria has been somewhat patchy.
The weight of the theoretical arguments and empirical evidence is consistent with the notion that the best contribution that monetary policy can make to sustainable growth is to maintain price stability. Because inflation is fundamentally a monetary phenomenon, monetary policy is the only tool that can effectively maintain price stability in the medium to long run. Thus, it makes sense that price stability is its primary objective. In addition, most of the empirical evidence and analysis shows that lower inflation is associated with higher long-term growth. While there may be doubts about the robustness of some of these results, there is little empirical support for the view that monetary policy should abandon the pursuit of price stability to increase long-term economic growth.
Monetary policy strategy can provide sufficient scope and flexibility for dealing with unexpected sizeable economic fluctuations consistently with the maintenance of price stability. By clarifying that it aims to maintain inflation rates below but close to 10.0 per cent over the medium term, the CBN has underlined its commitment to providing a sufficient safety margin to guard against the risks of hyperinflation.
The effectiveness, however, with which monetary policy can perform a stabilizing role is limited by several factors. These include the uncertainty regarding the timing and magnitude of its effects, which partly reflects the dynamics of the cycle, the nature of expectations and the type of shocks affecting the real economy. For instance, in an environment of very low interest rates and inflation or when the implementation of the appropriate economic policies is constrained, say by political obstacles to structural reform. In such situations, the effectiveness of monetary policy would depend on the underlying causes of the economic weakness and on the stance of other policies.
Monetary policy may be more effective if the problems being faced are perceived as short-lived, for example, caused by a temporary decline in consumer confidence. In such circumstances, a temporary monetary easing that does not endanger price stability may provide a stimulus to help economic agents cope with a cyclical slowdown. If, however, the economic problems are persistent and/or structural in nature, then monetary policy is likely to be less effective. For instance, if firms are reluctant to invest because of structural impediments implying few profitable business opportunities, a short-term monetary easing is unlikely to make much difference. In such circumstances, structural reforms aimed at raising trend growth can help restore confidence of investors. In this way, a change in the monetary policy stance can become more effective. Moreover, structural reforms that lead to an increase in aggregate supply and greater price flexibility can be expected to reduce upside risks to price stability and therefore give monetary policy more scope for maneuver.
To speed up economic recovery and achieve higher and sustainable growth in Nigeria, it is important for economic policies to strengthen confidence and enhance the competitiveness of the Nigerian economy. To this end, the implementation of credible fiscal consolidation strategies, based on growth-enhancing measures, can boost confidence and private spending, and thus counteract the direct effects of budgetary measures on aggregate demand. More importantly, the introduction of structural reforms to improve productivity and market flexibility is essential for increasing potential growth as well as international competitiveness in a sustained system.
These reforms could also help to increase confidence in Nigeria’s capacity to grow, with favourable effects on aggregate demand and economic activity in the short run. Monetary policy cannot help to solve the structural problems constraining the growth performance of Nigeria. The implementation of fiscal consolidation strategies and structural reforms will facilitate the conduct of the monetary policy so that it can foster growth while maintaining price stability.
In conclusion, my answers to the question: what stance should monetary policy adopt in a recession, like most economists is that it all deepends! It depends, in the first instance, on the objective of monetary policy. And in context, I believe the objective should be price stability, and stability only. It also depends on how credible monetary policy is. The greater the credibility, the less the chance that price stability and output objective will conflict, because of the adjustment of expectations. And it depends on the source of the shock to the economy that has induced the recession. If the shock is structural in nature, emanating from the supply side, then monetary accommodation is probably sensible. But to avoid actual or expected misuse of the departure from the price stability focus, such monetary accommodation should be very carefully circumscribed.
Onwioduokit is a Professor of Economics University of Uyo, Akwa Ibom State,, Nigeria. He be reached at firstname.lastname@example.org
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