- BOU claims it has done enough to keep inflation under check, implying it is government’s fiscal policy that is letting us down.
- Can BOU achieve macroeconomic stability without proper coordination of its monetary policy with the fiscal policy?
The statistics are out; and once again Uganda Bureau of Statistics (UBOS) is telling us that our economic situation can only get worse. Inflation has now hit 30.5%, and for the first time since this spike started in March, UBOS attributes the current upsurge on non-food merchandise (clothes, footwear, processed foods, beverages etc). This, again for the first time in a long time, led core inflation (the type that EXCLUDES food and utilities from the CPI) to accelerate above headline inflation (the type that includes ALL items).
Since the start of current inflationary pressures in March this year, we have been informed by our experts from both Bank of Uganda and government that this inflation was a supply-side phenomenon — caused by factors that hampered supply of goods and services, such as food shortages due to drought and floods, and high fuel prices following the drop in supply of oil as a result of the geopolitical tensions in north Africa and Middle East.
When some people attempted to attribute the inflation on printing of more money that was pumped into the economy during the February general elections (kicking off demand-pull inflation), both government and BOU rubbished this scenario. They denied any possibility that the current inflationary tendencies were demand-driven. I am one of those who agreed to government’s explanation that our inflation had everything to do with shortages as opposed to excess demand. However, the rate at which BOU has been tightening the monetary policy by raising the central bank rate (CBR), now standing at 23%, has left me in total bewilderment of what really is going on. And I am not alone.
Many people with some grounding in monetary economics or financial market theory (except bankers who self-interestedly are supportive of the current monetary stance), questioned the wisdom of BOU raising the CBR as a means to mitigate the inflationary pressures whose causes were NOT demand-driven. Our question is simple; if indeed the inflation was caused by supply factors, why then does BOU concentrate on mopping out money (a demand restricting initiative) instead of finding ways of stimulating production in the medium term? How would reduced demand for bank credit (on account of raised interest rates) stimulate production to boost supply?
BOU is on cram work!
Well, Mr President, as I have always told you, your textbook economists at BOU and finance ministry seem baffled by complex economic realities of Uganda which are oceans away from the textbook theories they learned and continue to learn from western universities. They hardly think about the on-ground realities of a cash economy such as ours when they cut-and-paste the one-size-fits-all monetary policies designed for Western Europe and America.
Indeed latest reports show that raising the CBR has not reduced demand for loans (which grew by 47% in September from 42% in July). This cram-work by BOU of thinking that every time there is inflation you need to mop out money could be hurting the economy further and worsening its already lower productive capacity.
Granted, over the past two decades, Bank of Uganda, particularly during the period under Governor Emmanuel Tumusiime Mutebire has put up a spirited fight against inflation that had ruined our economy in the 1970s, 1980s, and early ‘90s. Throughout his tenure, Mutebire, a known market fundamentalist, has kept a tight monetary policy stance by juggling a combination of tools ranging from raising the bank rates, to issuing government securities at the open markets, to increasing the reserve ratio requirement.
I have on several occasions expressed my disappointment with BOU’s obsession with tight monetary policy even in circumstances where it is ineffective, and/or counterproductive to the economy. Mutebire’s obsession with tight monetary policy has led to high domestic interest rates and has stifled both the lending activities of the banking system and the development of an effective interest rate channel of monetary policy transmission.
Where is the money being mopped out?
I suspect Uganda could be experiencing what in economics we call a ‘sacrifice ratio’ (defined as the cumulative loss of output, expressed as a percentage of current GDP, associated with a one percentage point reduction in trend inflation). In recent times, both trend and actual output has reduced. That is why even core inflation is rising.
I have always decried government’s failure to manage people’s expectations which contribute substantially to price and exchange rate instability. Bank of Uganda knows quite well that the individuals’ expectations about the future are an important determining element for the price level. The Bank has capacity to influences the individuals’ expectations and by that means indirectly the price level and the effectiveness the measures, which the Bank takes for its stabilisation. Instead, it opts for moping out money even at times when money to mop out isn’t available!
Mr President, another area where your economists have let us down is their failure to mitigate capital flight through strict regulation of the capital account. These guys know very well that one key prerequisite for monetary policy effectiveness is a relatively closed capital account. A standard Keynesian model with capital mobility would predict that monetary tightening would not lead to real exchange-rate depreciation but rather to both nominal appreciation, as higher interest rates fuel private capital inflows, and temporary real appreciation, as prices remain sticky in the short run. Despite this apparent knowledge even among textbook economists, ours at BOU continue to expose our economy to external financial shocks by keeping an open capital account.
Another area where I would want to pick a bone with our economists at BOU and Ministry of Finance is their failure to coordinate their respective monetary and fiscal policies. Recently we had an economic forum at Makerere University Business School (MUBS) where BOU’s chief economist, Dr. Polycarp Musinguzi, used rocket science econometrics to reiterate his boss Mutebire’s claim that the current inflationary pressures were more of a government’s letdown. He stopped short of indicating that their counterparts at Finance are failing their (BOU’s) effective monetary policy.
Mutebire vs. Muhakanizi
It is common knowledge that, just like many other countries, Uganda is undergoing a battle between the “monetarists” (in charge of the monetary policy at BOU) who favour low and stable growth of a monetary aggregate, and the “Keynesians” (in charge of the fiscal policy at Ministry of finance) who believe in fine-tuning and (in some cases) consider monetary policy to be ineffective.
But these guys at BOU and Finance know that Robert Mundell won the Nobel Prize for developing a theoretical model on how monetary and fiscal policies may be coordinated, indicating that failure to coordinate them well would make one counterproductive on the other.
I suspect Mutebire could not be seeing eye-to-eye with his counterparts at Finance, notably Keith Muhakanizi (your favourite de-facto PS, Mr President). We could be a distance but we his does not stop us from watching! The monetarism in Mutebire must be distancing him from working closely with Keynesians such as Muhakanizi who pay little attention to medium and long-run effects of an economic phenomenon.
These things, Mr President, are distressing policy coordination yet we know that in absence of proper coordination, the credibility of one policy (however good and effective it may be) can potentially be frustrated by inappropriateness of the other. It is, thus, essential for both your government and the BOU to sign on to an agreement, reaching specific inflation-reduction targets. This is the practice in well-functioning economies.
When your government changes fiscal policy, it needs to think of how these changes will affect inflation and, consequently, interest rates. Similarly, the BOU needs to consider how changes in monetary policy will affect demand and inflation, and thus its setting of interest rates. Therefore, it is to the mutual benefit of both parties to cooperate in the sharing of information and analysis as they set their policies. We are not running two economies, one by the Bank of Uganda and the other by government! Monetary economics teaches us that to have credible policies it is important that the authorities achieve the set targets. This is no longer the case with this government and it could be the reason Mutebire’s monetary policies are no longer as effective as they used to be.