Independent Monetary Policy Curbs Inflationary Momentum




Rosy reports are typical under the rule of the Revolutionary Democrats. Institutions do their best to highlight their positive performances and get praised for them. This trend is so pervasive within the state structure that government reports are received with grains of suspicion in academic and international financial sectors.

It is therefore not surprising to see that the first six-month report of the National Bank of Ethiopia (NBE), the ultimate monetary authority, paints a blissful image of the economy. Led by Teklewold Atnafu, a governor treated more as a politician than technocratic policymaker, the central bank departed from popular perception in its report which declares that the economy is stable. This stability, according to the report, comes as a result of the tight monetary policy stance being followed in the fiscal year.

Indicative of the stability of the macroeconomy the report mentions, is the relatively stable exchange rate of the Birr. Other indicators are the national foreign reserve covering 2.6 months of imports, improved financial inclusion and enhanced electronic transfer systems. Despite’s the report’s use of technical jargon to describe these indicators, they are visible even to laypersons.

Much has happened in all these aspects. The days of poor financial inclusion are waning fast. The reach of banks and non-bank financial institutions has grown so much. New transaction methodologies, such as mobile banking and agent banking, have taken finance closer to the doors of rural Ethiopians. Urban centres and towns are now enjoying the luxury of automated teller machines (ATMs) and point of sales (PoS) terminals.

Even if the national reserve is still lower than the popular global standard of three months of imports, it has improved from its low of 2.2 months of imports just a couple of months ago. The depreciation of the local currency, Birr, has relatively stabilised around 21.8 Br to the dollar. Compared to its fast slide of the past two years, the latest trend is optimistic.

Yet, it does not end there. Mentioned towards the end of the report are the challenges that remain to constrain the economy from achieving double digit economic growth. Top on the list of challenges is the widespread inflationary expectation embedded in the economy. In the words of the NBE, “considering the nexus between the current drought and food price hike, controlling inflationary expectation and stabilising prices would be the major challenge.“

Two things are obvious from the NBE’s analysis of risk. On the one hand, the Bank affirms that there is considerable inflationary expectation in the economy that needs policy attention. On the other, the Bank admits that the inflationary pressure will mostly like come from the food side of the equation.

Every inflation is a monetary phenomenon, most economists argue. Thus, it is right for the central bank, an authority entrusted to make sure that monetary policy serves its ultimate objective of stabilizing prices, to give signals about price expectations. There cannot be an agency better placed to send this signal out to the market than the NBE.

But if one is to seriously look into the report, the paradox will become vivid. The Bank reports that it has followed tight monetary policy in the fiscal year. However, it also mentions that it has borrowed (printed new money) 13 billion Br for the state and sold treasury bills worth 77 billion Br.

It is difficult to see where tight monetary policy is implemented, if not in controlling the excessive expansion of the monetary space. As it exists, the monetary space is just following the fiscal space. In a less technical sense, the creation of money in the economy is largely being defined by the intent of the political establishment more so than by the policy objectives of the central bank.

Seen under the prism of the popular economic argument, therefore, inflationary pressure is created by the crawling monetary policy. Instead of staying independent and settiing achievable targets in areas of price stability, the nation’s monetary policy remains subservient to the heavily politicised fiscal policy. It has therefore lost its ability to play its role in controlling inflation.

What is glaringly visible in the report of the NBE is that there is a prevalent confusion about the extent to which monetary policy has to be independent. In the strictest sense, the report is about fiscal policy performance more than that of monetary policy.

Of course, this confusion is not new. It rather is long overdue. Partly, it relates to the policy approach of the Revolutionary Democrats. Taking the experience of South Korea, Taiwan and China, the EPRDFites’ Developmental State theory argues that every institution has to serve the “developmental” agenda. This is defined by optimal rent collection and unrestrained intervention of the state in the economy. With respect to the monetary authorities, therefore, the issues should not be about policy independence but aggregate impact.

But the past two decades have proved, time and again, that a crawling monetary policy underpins an unrestrained fiscal policy. And at times, this nexus has been pushing prices up, as in the case of 2008, where aggregate inflation went upwards of 40pc. Furthering the downsides of the nexus is a state that takes comfort in the expansionary fiscal stance it follows. Assumed in this approach of the state is that it can twist the monetary policy as it likes and leverage it to meet its agendas.

One good thing that came out of the hyperinflation of 2008 is that the NBE made inflation its core policy anchor. This was maintained until the end of the first Growth & Transformation Plan (GTP I). Even under the GTP II, single digit inflation is a major monetary policy target.

But, to the dismay of Tekewold and his compatriots at the NBE, the outcomes have been far away from the policy objective. During the five years of GTP I, inflation roamed around 10pc, sometimes moving up by a percentage point. And in the first year of GTP II, the culprit stayed on the horizon of double digits, with a prevalent fear of its increasing.

Essentially, what is missing in the whole matrix is an independent monetary policy that sets its own targets and strives to meet them. The central bank ought to take away monetary policy from its long overdue subservience to fiscal policy. Monetary policy targets should not be guided by the fiscal stance of the political establishment. They rather ought to emanate from realistic growth projections, intended inflationary targets and aggregate employment estimates.

In an institutional sense, this job demands the NBE to act as an independent monetary authority with the objective of ensuring price stability and full employment. The era of standing as a flagellate of the fiscal authorities ought to end.

It is only when such independence is infused in the policy circle that monetary policy could serve its purpose and somehow restrain fiscal expansion. Else, the whole situation would be a vicious cycle of fiscal space expansion followed by monetary space expansion. The resultant outcome would be an oscillating inflationary cycle.

Draining out the inflationary expectation, indicated in the six-month report of the NBE, could only happen if essential independence of monetary policy is guaranteed. Everything else would be a quick fix to the macroeconomy. As the popular Ethiopian saying has it, “ploughing the surface forces a farmer to come back for weeding”.



Published on Apr 19,2016 [ Vol 16 ,No 833]


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