Dear Speculators,
For the fifth time this year, the Monetary Policy Committee (MPC) of the Central Bank of Nigeria will seat to decide on new monetary policies to influence the general economy to achieve their policy objectives. These objectives can be broken into four macroeconomic goals; economic growth, full employment, price stability, and exchange rate stability. The main policy tool of the MPC is the monetary policy rate (MPR) which is the rate at which the CBN lends money to banks.
Now it is almost impossible for the MPC to marry all the objectives by simply using interest rates. This is because while raising rates may favour the last two objectives, it is unfavourable to the first two objectives and vice versa. Understanding what drives each of these objectives is very important.
Economic growth is achieved through an increase in productivity in the economy, either through technology or an increase in skilled labour. Even zero rates in America and Europe hasn't been unable to bring about real economic growth nor was 14 percent interest rate in Nigeria able to save the economy from a recession.
Full employment is achieved by a continuous increase in the level of investments in the country. The investment growth will then absorb some of the excess in the labour market. Whether interest rate is at zero or hundred, investors will only invest if they believe that the potential return on investments will be greater than the cost of borrowing. Investors have borrowed both at the historical highest level of interest rate and at the lowest level of interest rates. The most important factor is not the rate of interest but the prevailing economic condition. If market conditions are decent, investors will invest.
Price stability is influenced by the supply of money. If the money supply in the economy is in excess, inflation creeps in. Interest rates is used to manage the supply of money in the economy. When inflation spikes like it has in recent months, interest rates must be raised to cut inflation and restore price stability.
Exchange rate stability is influenced by the balance of payment. If exports are greater than imports, the nation's currency becomes stronger and vice versa. In the past year, export earnings have fallen by more than 60 percent due to the fall in oil prices but imports have not fallen in a similar proportion, this is the main cause of the free fall in the value of Naira. Higher interest rates can be used to attract foreign capital into the country which can improve the current imbalance of payments and strengthen the Naira.
These are the main reasons why the CBN chose to raise rates during this period of recession. This is why inflation targeting is popular among Central Banks. The monetary authority cannot afford to ease rates at this moment to the detriment of the economy. We believe the MPC will chose to hold rates at this level. Those who understand economics understand the MPC.
For the fifth time this year, the Monetary Policy Committee (MPC) of the Central Bank of Nigeria will seat to decide on new monetary policies to influence the general economy to achieve their policy objectives. These objectives can be broken into four macroeconomic goals; economic growth, full employment, price stability, and exchange rate stability. The main policy tool of the MPC is the monetary policy rate (MPR) which is the rate at which the CBN lends money to banks.
Now it is almost impossible for the MPC to marry all the objectives by simply using interest rates. This is because while raising rates may favour the last two objectives, it is unfavourable to the first two objectives and vice versa. Understanding what drives each of these objectives is very important.
Economic growth is achieved through an increase in productivity in the economy, either through technology or an increase in skilled labour. Even zero rates in America and Europe hasn't been unable to bring about real economic growth nor was 14 percent interest rate in Nigeria able to save the economy from a recession.
Full employment is achieved by a continuous increase in the level of investments in the country. The investment growth will then absorb some of the excess in the labour market. Whether interest rate is at zero or hundred, investors will only invest if they believe that the potential return on investments will be greater than the cost of borrowing. Investors have borrowed both at the historical highest level of interest rate and at the lowest level of interest rates. The most important factor is not the rate of interest but the prevailing economic condition. If market conditions are decent, investors will invest.
Price stability is influenced by the supply of money. If the money supply in the economy is in excess, inflation creeps in. Interest rates is used to manage the supply of money in the economy. When inflation spikes like it has in recent months, interest rates must be raised to cut inflation and restore price stability.
Exchange rate stability is influenced by the balance of payment. If exports are greater than imports, the nation's currency becomes stronger and vice versa. In the past year, export earnings have fallen by more than 60 percent due to the fall in oil prices but imports have not fallen in a similar proportion, this is the main cause of the free fall in the value of Naira. Higher interest rates can be used to attract foreign capital into the country which can improve the current imbalance of payments and strengthen the Naira.
These are the main reasons why the CBN chose to raise rates during this period of recession. This is why inflation targeting is popular among Central Banks. The monetary authority cannot afford to ease rates at this moment to the detriment of the economy. We believe the MPC will chose to hold rates at this level. Those who understand economics understand the MPC.
Emeka Ucheaga,
Managing Partner,
Emeka Ucheaga Advisory
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