Inflation targeting as means of controlling price increase in Nigeria

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As Nigerians anxiously await the Central Bank of Nigeria (CBN’s) direction on the methodology of tackling the current high rate of inflation, JOSEPH INOKOTONG writes that inflation targeting may be adopted.

INFLATION targeting is a strategy used by central banks to achieve a specific inflation rate through the adjustment of the monetary policy rate.

The monetary policy rate is the ultimate monetary tool at the disposal of central banks and this tool can be used to achieve a specific goal of the inflation rate, maybe 12 percent or less. The goal here is to determine the amount of inflation rate needed for the economy using the monetary policy rate. The core of inflation targeting explains the significance of monetary policy and its effectiveness thereof.

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The Central Bank of Nigeria (CBN) defines inflation as a persistent increase in the overall level of prices of goods and services in an economy over some time. It is a situation where too much money chases fewer goods and services. Inflation often occurs in an economy when the economy is awash with liquidity due to a significant increase in the money supply without a corresponding increase in the production of goods and services.

When the general price level rises, a unit of currency buys fewer goods and services, thereby eroding savings, discouraging investment, stimulating capital flight (as domestic investors put their funds into foreign assets, precious metals, or real estate), inhibiting growth, making economic planning a nightmare and, in its extreme form, provoking social and political unrest.

A former President of America, Gerald Ford, stated that “when inflation approaches double-digit, it is “public enemy number one” while another president of the US, Ronald Reagan, described it as the “cruelest tax.”

It is on this premise that governments in almost all economies have adopted several measures to control inflation through the adoption of conservative and sustainable fiscal and monetary policies.

A monetary policy framework is a strategy that central banks use for conducting their monetary policy towards attaining the specified policy goal. The framework for monetary policy consists of the objective(s) of policy, along with the instruments and operating procedures for achieving the stated objectives.

Globally, there are different strategies used by central banks in the conduct of monetary policy. These strategies affect the operating, intermediate and ultimate targets through different channels. The common strategies include monetary targeting, exchange rate targeting, interest rate targeting, nominal gross domestic product or output targeting and inflation targeting.

Generally, as monetary policy objectives have evolved, so also the strategies (frameworks) used to attain them. As the names imply, those policy regimes target a monetary aggregate, exchange rate and inflation measure, output, or interest rate, respectively, in a bid to achieve the goal of price stability.

Every government enunciates policies (fiscal, price and income, as well as growth and development policy) to engender the growth and development of the country. These policies aim to achieve some objectives like a high rate of growth of real output in the economy; a low and stable rate of inflation; a low level of unemployment and ensuring a balance of payments equilibrium, among others.

To achieve these objectives, monetary authorities use monetary policy measures and instruments to control the value, supply and cost of money in the economy.

Inflation targeting is a monetary policy strategy in which a central bank forecasts and makes public a target inflation rate and then attempts to steer actual inflation towards the target through the use of key monetary policy instruments such as central bank policy rate, Open Market Operation (OMO) bills, repo and reverse repo and other monetary policy tools.

It is, therefore, a framework in which the primary goal of monetary policy is to achieve price stability in accordance with an inflation target. Of all the monetary policy frameworks, the preference for inflation targeting by many central banks in their pursuits of price stability objective is due to changing relationships between different measures of monetary aggregates and policy targets induced, largely, by financial sector liberalisation and deregulation, financial innovations, advances in information technology and globalisation.

The attraction of inflation targeting stems from the perception that it can anchor inflationary expectations much better than other monetary policy frameworks, especially when supported by a transparent operating and policy environment.

The difference between the actual inflation and the target under an inflation targeting regime determines how much monetary policy would have to be adjusted to steer actual inflation to the monetary authority’s target. Some countries have chosen inflation targets with symmetrical ranges around a midpoint, while others have identified a single target rate or an upper limit to inflation.

In many inflation targeting countries, inflation targets are set in the low single digits. It must, however, be stressed that an inflation target of zero is usually not appropriate because it would not allow real interest rates to fall sufficiently to stimulate overall demand when a central bank is trying to boost the economy.

There are certain features of inflation targeting. Again, the CBN report says the regime is characterised by several features. An important feature is that it specifies the inflation objective and a clear commitment to the achievement of the objective, given that monetary policy works in part by influencing inflation expectations.

It stated that inflation targeting is characterised by some features like proper definition of the type of inflation being targeted (core or headline inflation); choice of the measure to be used (producer price index, consumer price index, wholesale price index, or retail price index); accurate specification of the inflation points or range targets; institutional commitment to price stability as the primary goal of monetary policy by the fiscal and monetary authorities under an environment of effective fiscal and monetary policy coordination and with a commitment to achieving that target and a commitment to the transparency of the monetary policy process by the monetary authority, by engaging an effective communication with the market and public about its plans and objectives of monetary policy, accompanied by the central bank’s commitment to accountability in achieving the inflation targeting objective.

Also, the report states that there are preconditions for inflation targeting. It enumerates some of the pre-conditions for implementing an inflation targeting regime successfully including independence of the Central Bank as a major requirement for the adoption of inflation targeting in any country is a considerable degree of central bank independence.

This could take the form of instrument or goal independence and a monetary policy environment unconstrained by fiscal dominance. This means that the public sector borrowing from the central bank should be low or non-existent, while the government should have a broad revenue base to support its spending without a recurring recourse to the monetary authority for short- or long-term funding.

Another requirement is institutional considerations. This entails the domestic financial market having enough depth to absorb public and private debt placements, while the accumulation of public debt should be sustainable over time. The majority of inflation targeting central banks usually adopt a single mandate at a time. Where there are multiple policy objectives, such as high employment, exchange rate stability and output growth, other objectives must be subordinated to the price stability mandate.

There are also technical considerations whose major keys are the availability of data/information and appropriate sophisticated models for inflation forecasting to provide the monetary authorities with the right signals about the time path of future inflation to successfully achieve the target and guarantee sustained macroeconomic stability.

Types of inflation targeting abound in the literature, but three categories of inflation targeting have been identified. These include Full Fledged Inflation Targeting (FFIT), Eclectic Inflation Targeting (EIT) and Inflation Targeting Lite (ITL).

The inflation rate has continued to skyrocket in Nigeria with the attendant rise in the price of food items including commodities like cement, petroleum products, vehicles, etc.

The National Bureau of Statistics (NBS’) latest report on inflation rate in Nigeria said it rose to 29.90 percent in January 2024 from 28.92 percent recorded in December 2024.

The bureau puts the food inflation rate in January 2024 at 35.41 percent on a year-on-year basis, indicating 11.10 percent points higher compared to the rate of 24.32 percent recorded in January 2023. This means that in January 2024, the rate of increase in the average price level is more than the rate of increase in the average price level in December 2023.

The NBS explained that the rise in food inflation on a year-on-year basis was caused by increases in prices of bread and cereals, potatoes, yam and other tubers, oil and fat, fish, meat, fruit, coffee, tea, and cocoa. “On a month-on-month basis, the food inflation rate in January 2024 was 3.21 percent. This was 0.49 percent higher compared to the 2.72 percent rate recorded in December 2023.

“The rise in food inflation on a month-on-month basis was caused by a rise in the rate of increase in the average prices of potatoes, yam & other tubers, bread and cereals, fish, meat, tobacco, and vegetable. The average annual rate of food inflation for the 12 months ending January 2024 over the previous 12-month average was 28.91 percent, which was a 7.38 percent points increase from the average annual rate of 21.53 percent change recorded in January 2023,” the NBS stated.

The NBS reported that in January 2024, food inflation on a year-on-year basis was highest in Kogi at 44.18 percent, Kwara at 40.87 percent and Rivers at 40.08 percent, while Bauchi recorded 28.83 percent, Adamawa at 29.80 percent and Kano recorded 30.08 percent, the slowest rise in food inflation on year-on-year basis.

It further noted that on a Month-on-Month basis, however, January 2024 food inflation was highest in Ondo at 4.69 percent, Osun had 4.59 percent and Edo at 4.58 percent, while Bayelsa recorded 0.24 percent, Yobe at 0.97 percent and Ogun 1.44 percent recorded the slowest rise in food inflation on a month-on-month basis.

It is not certain if the apex bank will adopt inflation targeting as a means of addressing the rising inflation in the country. However, Nigerians anxiously wait for the CBN, whose primary mandate centres on price stability, to unfold the methodology on the way out of the present high rate of inflation in the country.