Understanding central banks’ decisions & impact on our economy 2023 (1)


… the issue of Monetary Policy Rate (MPR)

Inflation and currency depreciation are major economic challenges that countries around the world are facing. For countries like ours that rely heavily on international trade, these challenges can be especially difficult to deal with. In an effort to address these problems, central banks have relied on the use of monetary policy rate as a visible tool to control inflation. The year 2023 is a significant year for many; but for businesses, the market and the economy, it is important to stay informed about issues that could impact the economy and affect their operations. This article is intended to help the citizenry, business decision-makers, corporate strategists, and state officials to understand how possible events elsewhere can turn into external shocks on the local economy, and how these issues work.

It is also intended to help individuals and organisations understand basic policy interventions usually being used. The main goal of any central bank is to maintain price stability, which is usually referred to as ‘inflation targetting’. Inflation, which is measured by the Consumer Price Index (CPI), is a major concern for governments. It erodes consumers’ purchasing power, distorts economic structures, reduces economic competitiveness, and increases economic volatility.

Notable Event: In 2023, there will be many notable events, including changes in global population patterns and continuous investor uneasiness. For example, China is expected to lose its status as the world’s most populous nation to India, which will have significant impacts on investment decisions, economies, and production units around the world. Let us analyse the bond market. Japan is the world’s largest creditor economy, and holds trillions of dollars in overseas assets. This means that Japan’s financial sector is closely linked to the global financial market, and has the potential to affect it. Given the current state of the global financial market, it is possible that Japan could make the global recession worse.

Historically, Japan has always kept its interest rates low, even in the face of the pandemic and the energy crisis. Other developed nations, such as the United States, have continuously adjusted their interest rates. Currently, central bank rates between Japan and the developed economies keep widening.

This could have a significant impact on investor decisions. In 2022 for instance, the US Federal Reserve increased its interest rate from 0.25 percent at the beginning of the year to 4.5 percent at the end of the year. As the market continues to realise this gap, every rational investor may opt for a relatively better currency with a better rate of return such as the US dollar and US Treasury notes. Remember that as this happens, the value of the yen is also negatively affected. In effect, the yen has fallen in value, making imports to Japan expensive and therefore pushing inflation. In response, the Central Bank of Japan has had to do something it had not done in a long time: increase the cap on its 10-year bond to 0.5 percent at the end of 2022. Remember that the rate was at a mere 0.08 percent at the beginning of the year. Though a relatively small increase, this is enough to affect the market. There is an indication that in 2023, the Central Bank of Japan may increase its rate further not only on the long-term, but on short-term assets too. If these uneasiness continues to be felt by investors, there will be questions about the ability of the Japanese to service their public debts as Japan has the largest public debt in any developed economy (266 percent of GDP). Investors may offload their bonds, causing bold yields to go up. The ripple-effect will again affect global inflation, which – for countries as ours – can easily be imported to worsen our already weakened fundamentals. Remember that how these cycles work does not only affect emerging markets. They are neither as a result of a direct wrong turn made by managers of these economies, but their inability to enhance the economic fundamentals; and Ghana has already had its fair share of these effects.

The use of MPR

Monetary policy is an important tool used by many central banks to control inflation in the economy. Central banks usually do this through setting interest rates and engaging in open market operations to increase or decrease the amount of money in circulation. Of all the monetary policy instruments available to central banks, the monetary policy rate has somewhat been seen as the most effective tool for controlling inflation. A study I conducted to assess the effectiveness of monetary policy rate as a monetary policy tool for controlling inflation in Ghana (to be published later) used a time series data spanning from 1992 to 2014. Data was obtained from the Bank of Ghana, Ministry of Finance and Economic Planning, the World Development Index, and the Ghana Statistical Services for the study. The multivariate ARCH model was employed, and the results revealed that monetary policy tools in Ghana are relatively effective in controlling the levels of inflation recorded. Other research studies have generally found that changes in the policy rate have resulted in an overall decrease in the inflation rate in many countries. Several countries have also successfully used monetary policy rate as a tool to target and reduce inflationary pressures. For example, the US Federal Reserve has used the federal funds rate to combat high inflationary pressures. Similarly, the European Central Bank (ECB) has reduced inflation in the Eurozone by adjusting its main interest rate. In this regard, MPR is an essential instrument used for inflation targetting as we have in Ghana.

Understanding the MPR.

The MPR is simply the interest rate that central banks set that influences the cost of borrowing money in an economy. In effect, it translates to the interest rate at which commercial banks can borrow from the central bank. As an extension, with adjusted-risk margins, it is the rate at which businesses and individuals borrow from banks. Monetary policy rate is a broadly applicable and convenient tool to help modulate the money supply, inflation, and interest rate in an economy. It is typically implemented through changes in interest rates. The primary aim of such policies is to achieve desired price stability, economic growth, and job creation. There are usually two main goals to inflation targetting: achieving and sustaining low inflation over the medium term, and keeping price growth stable. When combined with effective fiscal and structural reforms, it provides a powerful tool to contain inflation and promote economic growth. The MPR influences short-term interest rates which are usually tied to almost all rates in our economy – consumer credit rates, mortgage rates, and the rates at which banks lend to one another. When a central bank increases the MPR, it increases the cost of borrowing money in an economy. This normally reduces the supply of money circulating in an economy, which in turn leads to an increase in the value of a country’s currency and vice versa. Additionally, the economic environment – in terms of economic growth, consumer confidence and investors’ expectations – is also an important factor in determining the effectiveness of monetary policy rate as a tool for controlling inflation, hence, the need for the central bank to be able to effectively communicate its objectives and intentions to the market in order for investors and consumers to respond accordingly to policy changes.

What we can do.

In emerging economies – such as Ghana – that are heavily dependent on imports, currency depreciation is a major source of inflation. When the local currency depreciates against the trading currency, the prices of imported goods and services increase. Remember the analysis mentioned earlier on happenings in Japan and its possible effect in 2023. As these imported goods and services make up a large part of a country’s consumption basket, the overall prices in an economy are driven up, leading to higher inflation. With the current global inflation and currency imbalances, central banking solutions for Ghana would need to be more comprehensive. In this regard, Ghana would have to approach the issue with a longer-term solution that involves building a strong and resilient macroeconomic environment that is not overly reliant on imports. This involves not just relying on the Monetary Policy Rate (MPR) to control inflation, but also using other monetary policy instruments such as exchange rate policies, capital controls, reserve requirements, and asset purchase programmes. Ghana must create and maintain a favourable external environment that increases capital inflows and encourages direct foreign investment. This could involve providing potential investors with stimulus packages, encourage capital investment in domestic infrastructure, develop the domestic manufacturing industry – such as the 1D1F industrialisation drive – and develop a strong confidence in the domestic currency. I am not only referring to government interventions, but also private initiatives. While economists largely agree that money supply is the ultimate determinant of the general level of prices, and by extension, excess money supply is the ultimate cause of inflation, the monetary policy transmission mechanism is not always clear. Communication by the Ghana’s Ministry of Finance and the Bank of Ghana, here, is key. To address this, the Bank of Ghana (BoG) must understand the elasticity of inflation with respect to monetary policy shocks in order to determine the amount by which it should change the value of the policy instrument so as to obtain a desired amount of change in inflation. BoG must also work together with government to address the underlying structural causes of inflation, such as supply-side constraints and financial instability. Overall, BoG must take a comprehensive approach to dealing with inflation that involves a range of policy instruments and alternative channels of policy transmission. This will require extensive coordination between the banking authorities, regulatory bodies, and government agencies as well as considerable empirical research into methods for improving the effectiveness of monetary policy. It is also important for individuals and organisations to understand how these issues work, their impact on lives and businesses, and how to prepare for them. We can also minimise the implications of these external shocks on our economy if we acquaint ourselves with policy interventions being used, assist with the solutions, and ensure that our economy remains stable and resilient.

The author is a management consult and economic policy analyst by profession. He is also an entrepreneur with interest in Global Strategy, Energy, Investment Advisory and Sustainable Infrastructure Solutions. He is the founder of Avar Investments, iNsaka Hub, Avar Energy and Architra SBV. He is also the director of the Dubai-based DICS Holdings.

Contact: [email protected]

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