Wednesday, March 01, 2017 10:15 AM/ Temitope Babalola, Research
Leading economic indicators are those economic series that tend to rise or fall in advance of the rest of the economy. They determine the direction of the economy and also suggest the turning point of the economy.
They provide the needed guidance or precursor to avoid been caught unexpectedly in a cyclical drawn back. Such indicators include the effective exchange rate (ERR), production manufacturing index, inflation, interest on call money, broad money (M2). Obviously the nature of the Nigerian economy makes oil price a leading indicator.
A prolonged depression in oil price would trigger a turning in the cycle and put pressure on both EER and external reserve. Presently most of the leading indicators are reflective of a position; where aggregate output moves in an opposite direction with inflation rate.
The chain reaction resulting from a sudden movement towards an opposite direction by aggregate output is accompanied by higher nominal interest rates, reduction in production capacity, dwindling business confidence and rising misery index. This is reflective of the cyclical drawback been experienced.
On the other hand, broad money (M2) presents a scenario where aggregate output moves in the same direction with interest rate and inflation; providing an underling macro picture of a positive shock, where growth is maintained. While gross domestic product has slumped to negative boundaries, money supply has maintained a growth path.
Although it is agreed that not every declining episode in broad money (M2) will beep the red light on a recession; Largely due to the inherent wild swing nature, that characterizes the money supply curve (fig1). Regardless it is expected that the drawn back already experienced in the macro economy will cause a roundabout effect on broad money; such that the rising risk to the real economy plunges the growth of aggregate credit.
Broad money (M2) has neither acted as a precursor nor suggested the right turning of the cycle so far. More interestingly monetary aggregate is not weighed down by the growing risk from the real economy.
Even after two quarters into a recession. Therefore we are gifted with a unique scenario, where both gross domestic product and broad money (M2) run at divergent directions. Strikingly, broad money grew by 8.2% in the same quarter, when the economy officially slumped into a recession.
Obviously, there is an impaired relationship between monetary aggregate and aggregate output. Another aisle of reasoning could conclude that broad money (M2) has become an impaired indicator. It’s in ability to act as a precursor at any points of the cycle, either before descending towards the trough or while still in the trough.
The impairment in broad money is responsible for the movement of monetary aggregates towards a positive shock direction: resulting into a disconnection between monetary aggregate and today’s economic reality.
Fig 1: A graphical illustration of growth and broad money from 1st quarter 2012 to 3rd quarter of 2016
Money market instrument have a strong impact on broad money (M2), thereby an increase in outstanding money market instrument have a direct impact on broad money (M2). Certainly when heavy injections are made to the fiscal authorities, using the money market as a conduit; it bolsters the growth of broad money.
As at the end of 2016, outstanding money market instrument grew by 20% and 6.3%, when compared to the previous half of the year and the previous year. Resulting into an addition of 1.790 trillion Naira and 636 billion Naira into the money market, compared to the previous half of the year and the previous year.
Thereby ensuring that the total value of outstanding money market instrument reach 10.606.33 trillion Naira by the end of 2016. When compared to the previous year, the total value of outstanding money market instrument was 8.8837 trillion Naira; presently making outstanding money market instrument 9.7% of gross domestic product.
Fig 2: A graphical illustration of outstanding money market instrument
Such, heavy injection will sustain the upward trajectory in the outstanding money market curve (Fig 2). While it will also ensure that broad money maintain its positive shock direction, even when aggregate output is jolted by a negative price shock. Moreover in a clime where high yields persist on such outstanding money market instrument, such yield will protect the existing alignment to a positive shock direction and how?
High yield provides the right nursery for asset rotation and cash replenishment for both non bank public investors and frictional banks respectively. Eventually the heavy injection is partly responsible for the impaired relationship between monetary aggregate and aggregate output. It is impossible to look up to an impaired indicator or an impaired relationship for guidance.
Rather both the indicator and its relationship to aggregate output are in need of attention and a corrective shoe. While it is understandable that issuing of federal government domestic debt is not within the ambit of monetary authorities but stoking off the high yield flame lies within its sphere of control. Stoking off the high yield will provide the first step in repairing the relationship between broad money and aggregate output.
Certainly, the lords and manors of the apex bank will have to consider either softening its high interest rate or slack its ongoing dynamic monetary sterilization in no distant future. A high interest rate coupled with a dynamic monetary sterilization cannot continue to run concurrently any longer; the presence of such concurrent nature strengthens the high yield scenario.
If there is no shift in any of the two, there is a possibility of having the hysteresis effect linger far longer after the recession is over. A holistic appraisal by the apex’s bank of its present structural framework where MPR is its nominal anchor and reserve money is the operating target is imminent, as it’s gradually losing its grip on monetary aggregates.
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