Central Banks have the unenviable job of trying to achieve conflicting goals, price stability, economic growth, low unemployment etc. In some cases, the economic environment is favourable and conducting monetary policy is fairly easy. In other cases the environment could be termed as hostile, where conducting monetary policy is tricky and the outcomes uncertain. Currently we are facing the latter. Although GDP has been forecast to rise by 5.5 percent, we are still faced with a fragile economy and rising commodities prices. The rise in commodities is not caused by an increase in domestic aggregate demand but rather world aggregate demand. This means that regardless of how much or little we demand, we will be faced with the same rising prices. In situations of rising prices, central banks raise the interest rates to slow down demand and ultimately inflation. The higher rates lead to higher cost of borrowing funds. The higher price of borrowing leads to businesses demanding fewer funds for investing from banks than before which in turn leads to slower output growth. In our current environment, with weak output growth, lowering interest rates should be the answer. Unfortunately lowering interest rates to spur growth might lead to demand pull inflation. This coupled with our imported inflation would just lead to more problems. On the other hand, raising interest rates to slow down inflation will be ineffectual at best and disastrous at worst.
In an ideal world, fiscal policy would be used to complement monetary policy. But if government is faced with budget constraints and interest payment equal to 20 percent of the budget, either raising government spending through debt issues or lowering taxes is not an option. In this case, there’s no short term solution. A currency appreciation would be a short term solution, although this would have a negative impact exports. In short, there is no quick fix to this problem and the job of a Central Banker would be termed as difficult as best.
No wonder the CB's job is unenviable, I mean even if they have to do something, it seems the situation force's them to thread carefully... But how carefully should they thread, because it appears the rising prices are not showing any signs of slowing down partly thanks to rising oil prices.
ReplyDeleteafter reading the page iI start wondering what will happen. What I mean is that if prices keep on rising- though not the fault of the central bank- demand will fall and if that happens what will be the results. This fall in demand might not just be by increasing prices but also reduction in the personal income taxes that have just been raised recently.
ReplyDeleteFrom my little knowledge of economics, I think this will cause a reduction in aggregrate and and hence output(GDP)
Growth in any case/ macroeconomic stability is not arrived at over night.Am afraid you sound too pessimistic Jallow and again you speak in truth as to the challenges many African countries are facing. In the face of Imported inflation, surely the best way is to allow the country to produce that which they demand from other countries in order to reduce the imported inflation. Its a finance decision really. if the costs are high enough to erode the once competitive advantage then why import. i know issues of consumer choice arise, but for the good of the nation, forex controls can be implemented. This would control the amount of import payments. Low interest rate should be the answer in addition to other Exchange rate policies and favorable export strategies. for sure no one policy can solve Gambia's problem in this case nor Malawi's.
ReplyDelete