Inflation Targeting and Central Bank of Nigeria

UDDIN, GODWIN ENAHOLO

NOVEMBER 2020

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 Inflation Targeting and Central Bank of Nigeria

Inflation Targeting as a measure (or monetary policy) adoptable by the Central Bank relates to
the setting of a specific inflation rate as a goal, and this inflation rate management procedure,
more often than not, applies to the core inflation rate – devoid of swings in food and energy
prices - in the economy.

Several reasons for which the Central Bank of Nigeria (CBN) or any Central Bank would resort
to use of Inflation Targeting as a monetary policy framework include: the policy could help
Central Banks achieve price stability, the Inflation Targeting measure could be a long term goal
for the Central Bank since such being a short term policy may hurt the economy, Inflation
Targeting forces the Apex institution to be proactive, forward-looking, and undertake regular
evaluation of her activities, and adopting the policy could help Central Banks forecast the future
path of inflation in their respective economies.

Notably, two key requirements are envisaged for successful implementation of the Inflation
Targeting framework, and they are: (i) Central Bank’s freedom (or Central Bank’s near
autonomy) i.e. first, independence in monetary policy choice - the Central Bank should be able at
will to choose (or select) and implement her desired monetary policy stance (and or
instrument(s)) without interference of fiscal authorities; second, existence of robust financial
markets – the financial markets should be able to conveniently absorb the activities of the
government (rather than the government been heavily indebted to the Central Bank, and or
heavily reliant on seignorage); and third, prevalence of sound banking system – the Deposit
Money Banks (DMBs) should be of strong health and able to support the activities of fiscal
authorities, and (ii) willingness of the Central Bank to relinquish control over domestic exchange
rate i.e. the Central Bank must solely focus on Inflation Targeting.

Whereas, other requirements acknowledged as also needed comprise the following: The Inflation
Targeting goal must be clear i.e. the inflation index sough to be stabilized must be specifically
identified, there must be a method to achieving the Inflation Target (and not sought to be
achieved arbitrarily), there must be operating procedures put in place, and there must be
sensitivity analysis done continually.

Meanwhile, the pros and cons attributable to the Inflation Targeting framework could be enlisted
as follows. For the pros, Inflation Targeting is reiterated as one that could instill discipline at the
Central Bank, and enable predictability and expectations on part of the people (or citizenry).
Also, through Inflation Targeting, the populace could be able to know the direction of the
economy. In addition, Inflation Targeting could help the Central Bank manage the economy
against downturns, to avert nationwide economic disasters.

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On the contrary, the cons are that, to some extent, Inflation Targeting is theoretical is nature
because managing future inflation can be unrealistic, and efforts to implement the Inflation
Targeting framework can undermine the favourable position of other macroeconomic variables
such as output, employment, exchange rate, etc.

In most developing economies however, the feasibility (or the possible adoption) of the Inflation
Targeting measure have been undermined (or made not possible) because the independence of
the Central Bank in choice of monetary policy tends to be hampered, sometimes by the deficit
budget financing, reliance on seignorage, etc. Also, the state of the financial markets is shallow
(i.e. not robust, or not heavily capitalized), and the banking system are sometimes fragile to
accommodate government activities.

For a country as Israel for example, the Central Bank had sought over the years since 1991 to
implement the intended Inflation Targeting plan but continually limited in varied respects such
as the setting of inflation target based on the all-item CPI – comprised of volatile prices of fruits
and vegetables, mortgage interest costs, and financial and wage contracts (partly informed by her
historical efforts to manage her costs of war, and trade relations), the rise in real wages of public
sector employees, and the people expectation of continued high rates of inflation which they
learn to live with, and this makes the Bank of Israel’s control over inflation more fragile.
Though, success stories in other economies such as Chile, Brazil, etc. may prove developing
countries could go beyond such constraints.

While for the case of Nigeria, there seem not to be a different instance but such similar to the
experience prevalent in other developing economies. Thus, it is seemingly implied that Inflation
Targeting has not been a viable option (or monetary policy framework) for the Central Bank of
Nigeria (CBN) and for the management of the Nigerian economy as, more often than not, the
autonomy of the CBN is frequently questioned by the executive and legislative arms of the
government, and her operations sometimes undermined by the activities of fiscal authorities in
the country.