The Central Bank of Kenya (CBK) has released a white paper in, which it envisions what it calls a forward-looking monetary policy approach.
This is differs from the current monetary aggregates targeting approach which has been in place since the substantial amendment of the Central Bank Act in 1996.
In modern economy, commercial banks create broad money whenever they make a loan. This runs contrary to the widely held view that banks can only lend out deposits that they already have.
In fact, it is loans that create deposits and not the other way round. However, there are limits to how much banks can create new money and monetary policy provides the ultimate limit.
By constantly calibrating the rate at which it lends money to commercial banks (known as base rate), the central bank sets the tone for the cost of money in an economy.
It can tighten or loosen its base rates, and this act of calibrating base rates directly affects the amount of lending that goes on in an economy.
Through this moderation, the central bank achieves its price stability objectives.
In the white paper, CBK wants to move away from targeting all the aggregates of money to targeting inflation.
But why? Kenya’s financial system has become more sophisticated to the extent that storing electronic balances is no longer the preserve of commercial banks. A significant number of non-bank actors have come into play, led by M-Pesa, of course.
As a result, demand and use of physical cash has been moderated. This has tended to weaken the thrust of using monetary aggregates as policy targets as has been manifested through excessive fluctuations in short-term interest rates.
In the envisioned forward-looking approach, the CBK makes public a numerical inflation target and then takes appropriate measures to steer inflation outcomes towards that target; and the apex bank says it has rolled out certain reforms towards the attainment of the same.
While modernisation of current framework was long overdue, I offer three criticisms of the white paper. First, inflation-targeting demands of complete central bank autonomy. I am not very sure that’s the case with CBK.
Secondly, in the era of fiat money, and where governments can print their way out of crises, monetary policy modernisation ought to now include full employment, something which is missing from the whitepaper (and this can be a whole debate).
To re-quote a former CBK governor, the bank has been accused of “pursuing price stability rather dogmatically while it ought to be focusing more on enhancing economic growth, especially given the current level of poverty in the country”.
Third, the paper is too lethargic when it comes to policy signalisation. I was expecting more reforms. Indeed, in an inflation-targeting regime, language and communication are core monetary policy tools.
To give you an example, on July 26, 2012, Mario Draghi, former governor of the European Central Bank (and current Italian Prime Minister) stood up and made the famous declaration: that the bank would do ‘whatever it takes to preserve the euro”.
That statement alone was viewed as so credible that Italian and Spanish bond yields fell by about two percentage points by the end of 2012, without the ECB actually having to make any bond purchases. That was the art of policy signalisation.
When it comes to CBK, I expected the following additional reforms on communication: (i) full transcripts of any MPC meeting to be made public; (ii) CBK governor to testify twice in a year to a parliamentary committee that deals with economic matters on the progress of achieving its objectives; and (iii) CBK to report on the state of its balance sheet on a monthly basis.
Twitter: @GeorgeBodo Website: http://www.callstreet.co.ke/blog-opinion
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