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Coronanomics (26) - CBN's Vexing Trilemma

Monetary Policy	1949 VIEWS
Monetary Policy
1949 VIEWS

Thursday, July 02, 2020 05:30 AM / by Proshare Content/ Header Image Credit: EcoGraphics

The single-sector bias of the Nigerian economy with its huge dependence on crude oil sales for 90% of its foreign exchange earnings and 70% of its fiscal revenues lays out a path to a perfect trilemma:

The first problem is that if the CBN tries to stimulate the economy through monetary expansion it would create massive inflationary pressure as added liquidity would meet with heavy domestic supply logjams as manufacturers, wholesalers and retailers find it difficult (if not impossible) to restock production inputs or finished products as a result of global supply chain challenges and domestic logistic disruptions caused by countries closing their borders and ports. More money chasing the dwindling supply of goods merely raises consumer and producer prices.

Chart 134: Nigeria's Inflation Rate (%) January 2019 - April 2020

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Another major problem faced by the CBN is the question of whether it should continue maintaining the exchange rate at the expense of depleting foreign reserves.

Chart 135: Nigeria's External Reserve

CBN and The Rest of The World

Analysts believe that the CBN's policy response to the novel Coronavirus or COVID-19 was late. The argument was that the central bank needed to have anticipated the consequences of an economic slowdown and put a counter-recessionary monetary framework in place as early as the first known incident of the virus in February 2020. This may be somewhat of a stretch. The problem with the COVID-19 virus response by central banks globally was that they adopted swift monetary policy responses to what was essentially a public health challenge, the monetary policy measures were more appropriate for issues related to insufficient domestic liquidity than supply chain disruptions caused by the pandemic.

In other words, the challenge is not one of stimulating growth by lowering interest rates or increasing money supply but that of taking charge of the pandemic by limiting and reversing its spread. The slowing down of the disease was a health management problem and not an economic policy challenge. The use of monetary and fiscal tools could only prove effective when supply chains are settled and manufacturers kickstart production. The revival of production would require re-establishing forward contracts and ensuring that demand cycles were restored. The point of the relevance of interest rate cuts and money supply growth would be to reduce production costs and improve demand by off-takers and consumers, two events that were relevant only after the taming of the pandemic.

To get a handle on the economic consequence of supply chain disruptions it has been necessary for policymakers to craft a realistic projection of what the economy would look like (see Table 22). The table gives insights into where the Nigerian economy may head in 2020.

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