Whither Our Monetary Policy?

- Dr Mark Assibey-Yeboah

When the Monetary Policy Committee (MPC) of the Bank of Ghana (BoG) met last week, it added its voice to the subsidy debate, categorically suggesting that fuel and utility subsidies must be removed.

And the government has obliged!

Clearly, the bank had been under intense political pressure to wade into the debate. For the uninitiated, the BoG’s mandate does not include giving unsolicited fiscal policy advice in the open.

In 2012, the country incurred a fiscal deficit of GH¢8.7 billion (12.1 per cent of Gross Domestic Product (GDP), against a target of GH¢4.7 billion (6.7 per cent of GDP). The BoG explains this deficit as mainly due to a shortfall in corporate income taxes, excess payments in respect of the Single Spine Salary Structure, higher interest cost and higher utility and fuel subsidies.
The stunning deficit cannot be blamed on only the above. What the bank failed to add was the frivolous government borrowing and spending in the run up to the elections, to the extent that total public debt stood at GH¢33.5 billion (46.7 per cent of GDP) in 2012, compared with GH¢24.0 billion (42.6 per cent of GDP) in 2011. This high debt-to-GDP ratio is what is pushing the government to remove subsidies, and limiting its spending options too.

These are the critical issues the bank should have attended to if it really wanted to proffer fiscal policy advice, instead of telling us that subsidies must go.

In announcing its policy decision, as expected, the bank did not make any changes to its monetary policy stance, leaving the policy rate at 15 per cent.
That, for me, is the most critical failing of the bank.

Ghana’s trade deficit is ballooning. We had a trade deficit of US$4.2 billion in 2012, compared with US$3.1 billion in 2011. The GDP growth too is declining. Provisional estimates put real GDP growth in 2012 at 7.1 per cent. But the inflation rate remained unchanged at 8.8 per cent as of January 2013.
The bottom line is that Ghana’s economy continues to struggle, mainly due to the inability of business investment to drive it. Yes, there is strong consumer confidence in the economy and the government too, to all intents and purposes, stands prepared to spend to stimulate the economy. But, clearly, the missing ingredient is business investment.

And this is what has bolstered my case for monetary easing.

Background

Should price stability be the primary goal of monetary policy in Ghana? As our economy grows at pre-oil find levels, the key challenge we face as a nation is job creation, with its attendant economic growth and development. In light of this, policy makers and research economists are now questioning the idea of macroeconomic stability with growth championed by the International Monetary Fund (IMF).

This op-ed attempts to fill a gap in our discourse on monetary policy by bringing other alternatives to the forefront. I argue that a loose monetary policy can influence the performance of the aggregate economy. Therefore, my preference is for high employment at the expense of low inflation.
Chronic high inflation has been a problem in Ghana, with its main causes being external shocks, unsustainable macroeconomic policies and exchange rate depreciation.

Inflation:
- creates uncertainty and difficulty in planning for the future;
- raises commodity prices, and
- lowers economic growth.

The main challenge for the BoG, in my estimation, therefore, is to limit an inflationary shock to a one-time pass through in order to avoid agitation from labour unions for wage increases.

Monetary Policy in Ghana

Monetary policy involves changing the supply of money to affect interest rate, investment demand, employment and output. Policy is focused on the demand side of the economy, stimulating it or restraining it as required. The key aim of monetary policy for most central banks is to keep inflation low and steady. The main instrument of monetary policy is the interest rate.

That said, central banks should not be indifferent to economic growth and unemployment.

The BoG, in recent years, has focused its efforts on controlling inflation. In May 2007, the bank announced formal inflation targeting, otherwise called IT lite, since exchange rate stability is an important intermediate objective.
Inflation targeting is the public announcement of a medium-term numerical target for inflation with an institutional commitment to price stability.

Effects of Tight Monetary Policy

Increases in interest rates raise costs that are passed on to consumers as higher prices. Therefore, higher interest rates lead to slower growth and lower tax revenues, without any apparent benefit in terms of lowering inflation. An increase in interest rates also decreases aggregate demand (or reduces spending).

Domestic credit and the quantity of money also tend to decrease in the face of tight monetary policy. Additionally, higher interest rates lead to greater expenditure, resulting in higher deficits.
Moreover, in Ghana, high interest rates have not brought in the expected capital inflows. Such contractionary policies, if allowed to continue, will reduce real incomes and lead to political instability.

The Way Forward
Interest rate cuts avoid, prevent and eradicate recession, as it stimulates demand for businesses. In a country in which unemployment is always high, the BoG should seek to achieve a moderate inflation rate, while lowering unemployment. To promote economic growth, I argue that BoG policy must encourage real investment that will improve employment opportunities, reduce poverty and support development.
To this end, we should rather risk high inflation for a couple of years than accept a decline in the growth rates of GDP.
For businesses to be able to borrow at attractive rates, the BoG should:
- lower the policy rate to less than 10 per cent;
- exhort banks not to increase rates unnecessarily, and
- stand ready to supply any amount that banks may require at (cheaper) lending rates.
The likely benefit of lower rates is large, compared to the potential damage. High unemployment and low capacity will prevent lower interest rates from driving up commodity prices.
Monetary policy is a potent force; “Quantitative Easing” could also be explored. Thus, it is my hope that the new Governor of the BoG will be more aggressive than his predecessors and adopt the “whatever-it-takes” central banking approach that is now popular across the world.
After all, there aren’t any monetary policy taboos.

The writer is the Member of Parliament for New Juaben South. He previously worked as an Economist at the Bank of Ghana.