Monetary Policy Processes MONETARY POLICY FRAMEWORK IN GHANA: In Ghana PRACTICE AND CHALLENGES Presentation by Millison K. Narh Deputy Governor, Bank of Ghana At the International Conference on Transitioning to Modern Monetary Policy Frameworks in Low Income Countries Organized by the Bank of Uganda in collaboration with the IMF, At Kampala, Uganda, March 17-18, 2014 0
Outline Three distinct phases of monetary management Factors informing the switch Requirements: Legal, institutional, data and design Record of performance Challenges and prospects Conclusions slide 1
A. Phases of Monetary Management Recognise three distinct phases of monetary management in Ghana: Control regime (price, exchange, credit and distribution controls) Monetary targeting (associated with reform and structural adjustment) Inflation Targeting Disincentives created by controls and consequent contraction resulting from the control regime led to a shift to liberalisation. 2
Targeting Monetary Aggregates: Issues that confronted the Bank of Ghana Monetary Targeting from about 1986. Central role assigned to targeting of monetary aggregates; Reserve Money. Decades of changes in the economic structure and reforms had impacted on the income velocity. The unstable nature of velocity made it difficult to control the demand for money function. High growth rates in money had increasingly become insignificant in explaining Monetary Policy price Setting in fluctuations Ghana 3
Relationship between money & inflation Ghana: money and inflation (Jan 1981 Jul 2013) 110.0 110.0 90.0 M2+ Inflation Rate 90.0 70.0 70.0 per cent 50.0 50.0 30.0 30.0 10.0 10.0-10.0-10.0 Jan-71 Jan-73 Jan-75 Jan-77 Jan-79 Jan-81 Jan-83 Jan-85 Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Per cent slide 4
Re-examination of Money demand Function The re-examination of the money demand function necessitated by observation of high and volatile monetary growth, that occasionally overshot targets, while inflation remained low and stable. The paper concluded that evidence from the statistical and econometric methodologies showed parametric shifts in the demand for money function (following the period of steady structural reforms and financial sector deregulation). slide 5
Re-examination of MP transmission Studies on re-examination of the monetary policy transmission mechanism showed some shifts in the transmission mechanism from the monetary channel to interest rate and expectation channels. However, the monetary and exchange rate channels continue to play some important roles in explaining the variations in prices and output. Supports the effort by the MPC to continue to pay particular attention to the exchange rate and monetary variables in monetary policy decisions. slide 6
Technical Studies. These findings had an important implication for viability of framing monetary policy around monetary aggregates Implied money growth rates alone were not good predictors of future inflation and real output. and provides support for the current policy regime (IT) where several indicators are considered in taking monetary policy decisions rather than only money supply. A recent study (2011) on Ghana by the IMF arrived at the same conclusion (WP/11/274). slide 7
The Shift to the Inflation Targeting Framework: Legal and structural Issues slide 8
Process of shifting to Inflation Targeting Framework The process started with a statutory or operational independence for the Central Bank A public announcement of an explicit quantitative target for inflation the rate that is perceived to be appropriate for the economy - to be achieved within a specified time horizon Though the IT represented a comprehensive framework, the BoG needed an implementation period. The BoG set for itself a period of 5 years, beginning September 2002, to put in place all the legal, institutional, accountability and operational plans of the framework of Monetary Policy. 9
The Regulatory Framework A new BOG Act, 2002, (Act 612) set the tone for IT in Ghana: The primary objective of the Bank is to maintain stability in the general level of prices (Section 3, subsection 1). Without prejudice to the above, the Bank shall support the general economic policy of the Government and promote economic growth and effective and efficient operation of banking and credit systems in the country, independent of instructions from the Government or any other authority (Section 3, subsection 2). The new Act thus granted the Bank operational independence. slide 10
The Regulatory Framework The Act also tackles the issue of fiscal dominance through: Placing a limit on government s borrowing in any fiscal year Provides for the establishment of a Monetary Policy Committee (MPC), responsible for initiating proposals for the formulation of the monetary policies MPC eventually adopted IT framework as monetary policy strategy and began to operate an implicit IT in 2003 slide 11
Issues regarding the Institutional Framework Who sets the inflation target? Joint, in the case of Ghana Commitment period and target horizon for the achievement of the target must be stated explicitly: 18 24 months horizon The choice of an appropriate price index to use: Ghana uses the CPI All price Index, but monitors core inflation at different levels Point or range target must be defined: Ghana uses a range target. slide 12
Issues regarding the Institutional Framework Selecting an instrument: For the BoG it is the Monetary Policy Rate (MPR) Periodicity and frequency of meetings. The MPC meets 6 times in a year but dates reflect availability of macro data and survey results. Size of the Committee: 5 internal, 2 external. The inflation forecasting process: Types of models used include the AR Process, Error Correction Models, Calibration of the CPI baskets and Macro model Institutional arrangements in place to achieve forecasting goals slide 13
Initial constraints Real sector data was unavailable (contemporaneous data on real sector) Within the IT framework, the duty of the policy makers is not only to determine the path of inflation, but to also gauge how the real sector of the economy responds to monetary policy decisions Misconception that the IT framework focuses narrowly on targeting inflation. The loss function of the Central Bank is expressed as a function of the inflation gap and the output gap. slide 14
Initial constraints The Ghana Statistical Service started generating quarterly data on GDP in Q4 of 2010 but releases are still a quarter lag. The challenge for the BoG was how to get around the problem This was resolved through various approaches using surveys: Developing and monitoring movements in the Composite Index of Economic Activity (CIEA), which serves as a leading indicator of GDP outcomes Gauging consumer and business sentiments through surveys and construction of consumer and business confidence indices Assessment of inflation expectations: consumers, businesses, financial sector and research organizations slide 15
Accountability Issues Main vehicle for communicating decisions to the public is a Press Conference during which the Governor makes a statement and answers questions Decisions are made by consensus. Governor has no regular vote, only casting vote to resolve impasse. Timely release of economic reports to economic agents. Reports explain deviations and give information on factors that went into the decision-making. Parliament has the power to summon Governor to explain certain aspects of decision or recent economic trends. slide 16
Institutional Reforms Further steps were taken during the transition to reform the money market to ensure effective transmission of monetary policy. This involved Rationalizing the minimum reserve requirements for banks Abolished the secondary reserve requirement by August 2006 (35% on Comm. Banks deposit) Introduction of a corridor system to create incentive for banks to deal among themselves and signaling role of the monetary policy. Open market operations continue to be used for liquidity management. slide 17
Other Financial Sector/Payments Systems Reforms. Payment systems reform (RTGS, CCC system and ACH, GIPSS common switch with interoperability features) Credit Reference Bureaux Collateral Registry Central Securities Depository Licensing of MFIs to promote financial inclusion slide 18
Overall Monetary policy management at the Bank of Ghana depends on a whole set of economy-wide information as well as underlying models of the economy. No single indicator is sufficient and the Monetary Policy Committee relies on various indicators and analysis in making a judgement on how it positions its key policy rate. Above all, judgment of the policy maker is crucial as an essential element of the decision making process. slide 19
Record of Performance slide 20
Performance So Far... MP under the IT regime has played a key role in stabilizing the economy per cent 120.0 100.0 80.0 60.0 40.0 20.0 Ghana: inflation 160 140 120 100 80 60 40 20 0 per cent Ghana: Inflation and Growth GDPgrowth CPI Inflation 20 15 10 5 0-5 per cent -10-15 - 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011-20.0 slide 21
...and the exchange rate remains generally stable although effects of shocks are noticeable Exchange Rate Volatility (GH /$ rate) 0.200 0.180 0.160 0.140 0.120 0.100 Controlled regime with discrete devaluations 0.080 0.060 0.040 0.020 Global Commodity price shock (Oil prices surged; Cocoa prices tumbled. Global financial Crisis 0.000 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 slide 22
Transmission of MPR has improved Transmission of policy rates to market rates have improved Realignment of interest rates within a corridor Transmission of policy rates to the macroeconomy has also improved. For example a 1 percent change in MPR results in lowering inflation by 0.3 percent in six quarters. slide 23
Realignment of interest rates within a corridor Repo slide 24
Response of CPI and GDP to 100bps increase in MPR Inflation Real GDP slide 25
0.0-2.0-4.0-6.0-8.0-10.0-12.0-14.0..but there are problems with fiscal dominance and this is keeping interest rates high (significant cyclical fiscal patterns) 2000 2001 Fiscal Deficit (% of GDP) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2000 2001 2002 Ghana: Total Public Debt (% of GDP) 2003 2004 2005 2006 2007 Domestic External 2008 2009 2010 2011 2012 200.0 180.0 160.0 140.0 120.0 100.0 80.0 60.0 40.0 20.0 0.0 slide 26
Challenges and Prospects Monetary policy in Ghana has evolved. IT Framework has revolutionized the way monetary policy is conducted. The IT framework has led to a more organised and transparent way of conducting monetary policy The framework has imposed a lot of data requirements on the process and has required the Central Bank to expand the frontiers and boundaries of its real sector database. Framework has also made forecasting a regular feature in the process, allowing the bank to update itself on the dynamics of domestic and external economies and to slide 27
Challenges and Prospects The Bank of Ghana is still on a learning curve as far as its IT framework is concerned. The internal processes leading to decision making are still being perfected. Specifically: Continue to review the questionnaires for the Business and Consumer Confidence Surveys to reflect the needs of the committee. Re-examine the CIEA in the light of current economic and institutional developments (Example to include the oil addition to the economy, etc): Explore ways of expanding core models framework to Monetary Policy Setting Ghana incorporate dynamics reflecting the Ghanaian slide 28
Challenges and Prospects Destabilizing effects of portfolio flows reflecting opportunities in terms of higher yields elsewhere. Continue to improve the transmission mechanism (asymmetric pass-through in the short run). That is, when interest rates are falling, banks tend to take more time to adjust their retail rates..banks adjust more quickly to rising interest rates Dealing with major inflation shocks that lead to permanent deviation from the target Time inconsistency challenge. Fiscal dominance is still an issue but policy coordination with fiscal still being streamlined slide 29
Conclusions MP is a dynamic process and occasionally adjusted to reflect prevailing conditions. Ghana adopted the IT framework since 2002 and MP mechanism has worked fairly well associated with lower levels of inflation. Nevertheless, challenges remain, including long lags in transmission process, vulnerability to external shocks, etc Accompanying institutional and money market reforms are still on-going to firm up the MP transmission process. slide 30
Thank You for Your Attention slide 31