Emmanuel Tumusiime-Mutebile.
By TUMUSIIME-MUTEBILE
In Summary
- Inflation targeting frameworks place great emphasis on sending a clear message about the stance of monetary policy and on influencing inflationary expectations through careful communication by the central bank with the public and the markets.
When we talk about the transition to modern
monetary policy frameworks in low income economies in Africa, we are in
essence discussing the shift from a monetary targeting framework and, in
a few cases, a fixed exchange rate framework, to an inflation targeting
monetary policy framework.
The term “modern monetary policy framework” is
virtually synonymous with “inflation targeting.” Some countries in
sub-Saharan Africa have already adopted an inflation targeting
framework; South Africa, Ghana, Mauritius and Uganda.
Other countries are implementing hybrid monetary
policy frameworks that retain elements of monetary targeting along with
elements of inflation targeting, such as setting a publicly announced
policy interest rate.
But what is the motivation and what are the implications of introducing inflation targeting regimes to low income countries?
Over the past two or three decades, monetary
targeting frameworks have served sub-Saharan countries quite well.
Monetary targeting brought down inflation in many low income countries,
including Uganda in the early 1990s, and maintain it at moderate levels
for sustained periods.
From the 1990s, macroeconomic management has
markedly improved and monetary policy has made a major contribution to
this improvement.
Since the turn of the millennium, the median of
the average annual inflation rates of sub-Saharan low income countries
(excluding the fragile states and those that are members of the CFA
franc zones) was 8.7 per cent, compared with 17.3 per cent in the 1990s.
Many low income countries have annual inflation
rates at single digit levels. Paradoxically, it is the achievements
brought about by improved macroeconomic management that are starting to
render the monetary targeting frameworks obsolete in many of the low
income economies. This is for three reasons.
First, monetary targeting frameworks are usually
an effective tool for bringing down high rates of inflation, but they
are too crude an instrument for controlling inflation that is already at
low levels, as is the case in many low income economies.
Secondly, the success of macroeconomic management
in sub-Saharan Africa over the past two decades has spurred substantial
progress in financial deepening and diversification, together with the
spread of innovations such as ATMs and mobile banking.
In addition, the financial systems of many of the
low income economies have become more integrated into global financial
markets, with several of these economies now classified as “frontier
markets.”
Frontier markets are attracting portfolio capital,
much of which is intermediated through their banking systems. The
development and global integration of financial systems in sub-Saharan
countries have weakened the stability of the income velocity of money
and that of the money multiplier on which the efficacy of monetary
targeting depends.
Thirdly, monetary targeting frameworks provide a
relatively robust way of managing monetary policy in an environment
where an understanding of the processes of inflation is limited, and
where accurate data to analyse these processes is lacking.
For example, movements in the exchange rate will
clearly affect inflation in open economies but play no role in a
monetary targeting framework
.
The improvement in capacities for macroeconomic
management, and in the quality and depth of statistical data which have
taken place in many low income countries, now affords central banks an
opportunity to apply more sophisticated approaches to monetary
management that can take better account of the factors underlying
inflation and output
.
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