Bank of Tanzania Policy shift
As announced today 3rd of January 2024, the Bank of Tanzania (BOT) is moving away from its traditional policy framework of managing quantity of money to interest rate framework.
As started in the bank memo, the aim of such implementation is to achieve the following:
(i) Efficiency (ii) effectiveness and (iii) resiliency
Although not that explicitly, that is the message I gather in the A4 document. Simply put:
The efficiency objective will ensure that the bank delivers this interest rate control without imposing excess cost in terms of time or money to all users, and without soliciting any inconvenience expenses from the central bank.
The effectiveness requirement to ensure that the framework should be effective in transmitting the policy rate to the broader economy and financial markets. Thus, this rate set by BOT will the base rate for all other interest rates.
The last objective of the policy shift is to guarantee resilience-, which means that, this shift should works under a broader set of scenarios. As stated, it can be used to stabilize the economy during recession (rates should be decreased) and expansion (rate should be raised). The memo also highlights that this rate will move in line with other policies such as fiscal policy to guarantee its effectiveness.
The motives for the bank shift could be the increasing economic turbulence globally which have been ongoing since COVID-19 pandemic and the dual wars in Ukraine and Middle East. Under this scenario, no pre-existing playbook that the bank can use to stabilize the economy and of course the incentive to search for new tools. In world of rising uncertainty and recurring economic and political shocks, it is judicious for BOT to adopt such a mechanism, which help it to adapt and respond quickly to these changes. Agility and resilience will definitely be a competitive advantage in these choppy environments. Although it is not immediately clear, I think Mr. Tutuba is in the money on this one.
From the investor’s point of view the growing influence of central bank in the management of rates, is going to have overreaching consequences on stocks, fixed income returns and will likely to only reflect in wealth effect in long term window than short. Investors will do well to study history of bank’s policy shift around the world to draw lessons of similar nature. Such view and take is a worth exercise.
Prominently the global uncertainty caused by war and the pandemic have caused huge supply shocks ranging from supply chain disruptions, undermined labour force participations, which have also coincided with other structural shifts in globally. All these have accelerated the need for change in monetary policy for many economies. Some of these structural changes are such as the climate change, energy transitions, deepening geopolitical divide and fragmentation of global economy into competing blocs, which have resulted in trade and investments restrictions between countries, the potential challenge or regional integrations. All these conditions will have over reaching consequences to the inflation dynamic.
Few economies including Tanzania have experienced a mild episode of FX shortages and rapid prices swings in imported goods such as fuels and consumer goods. Others economies in the region are still not out of the wood with their debt interest payment dues and reserves shortages. In time like these, prudence macroeconomic policies are invaluable. The old adage of “the dollar is ours but is your problem” remain valid today and so long as nation do not have a better substitute, they will have to work overtime to remain liquid in these hard currencies. Gold purchase was my previous article- titled Bank of Tanzania goes Gold shopping-which explain the rationale.
So what are the Pros and cons of the policy shift; few there are!
The quantity of Money frame work (old stance)
For those less initiated in the lingua Franca of economic- quantity of money framework is premised on the assumption that changes in the quantity of money causes changes in its purchasing power, as measured by some price index say CPI. The biggest critique of this framework is that it lack the link between aggregate output and employment.
For example, speed- the quantity of money framework as monetary policy transmission mechanism is slow, therefore often less effective in harmonizing the economy in the event of any deviations arising from either endogenous or exogenous shocks. There is some evidence of the bank policy working, looking on it is unannounced move towards single digits in its treasury paper issuance, which have helped to direct capital in other investments and reduce the liquidity drought or could it just be January effect? It will be interesting to monitor those premia throughout the year.
Another interesting challenge the bank faced using money supply as policy is that money supply is not only a crucial determinant of long run inflation in the economy, but also a strategic variable in the bank transmission mechanism which price level dynamic in the long run and income and employment dynamic are linked to policy actions. In 2024, the expectation is that many economies including Tanzania, will have operate in the world were competing policy (monetary and fiscal policy) in a high debt, high interest rate world. It worth remembering that stable public debt dynamics around a well-defined steady state is a precondition to ensure price stability when the central bank use interest rate as their policy instrument and public obligations are nominal (Woodford, 1994).
However, the theory is clear on policy preference between fiscal and monetary. Monetary policy is superior when it comes to implementation. Example discretionary monetary policy can be executed rapidly (wraps speed during COVID- go see the data on growth of money supply then) than fiscal policy can. An if you happen to have sat in any economic class during macro session you will recall that monetary policy is much less subjected to implementation lags compare to fiscal policy. If not go back to your notes and of course, you can always read Taylor (2000) and Fontana (2009) on the subject. Actually, Taylor (2000) expound broadly the limitations of fiscal policy as policy tool during economic cycles.
The fundamental assumption regarding quantity of money framework implemented previously by the bank was based on the assumption that it does gear the monetary policy to the pursuit of money-growth targets. However, there is no sufficient causative evidence to validate this position, which could explain the bank shift away from it. Moreover, the enjoyed speed of monetary policy during COVID-is now becoming costly as inflation keep raging in advance markets.
The expectation is that this adoption will enhance all the 3 mentioned benefits of the framework and all financial markets will be in sync with BOT policy rate which of course will create credibility in the economy, both locally and globally. After all, accommodative monetary policy have often being used as a moderating tool to drive economic growth, especially when there is an upsurge in public investments spending. From this position, it is hard to fault Tanzania in government investment spending. Of which it has resulted in short-term stable growth and likely to increase productivity capacity in the long run. The Central Bank as government banker have results to show. Even the move to buy gold as an FX volatility mitigation move, although is marginal currently, might just be golden bullet in the future. Yet, policy asymptote are hard to forecast and this one is no different. The economy does not respond symmetrically to policy changes and therefore we should expect sometime before the effects of the change being pronounced in other economic activities and data at least.
From the literature, policy choices of central banks varies depending on the nature and the structure of the country economy and therefore there is no one size fit all. In fact, it policy framework shift is risky despite all its merits. However, as the BOT memo explained the policy shift is adopted because it fit well with the Tanzanian economic context and the bank mandate which is to stabilize price (manage inflation) and promote long-term economic growth. Moreover, of course the rather odd comment given that, they are doing because the other in the region have done so. Nevertheless, the document, though not explicitly seems to suggest that the bank (BOT) ability to supply liquidity without losing interest rate control is also suitable in maintaining financial stability.
Whether BOT dual mandate of price stability and economic growth is an achievable goal , it remain to be seen, for it will require the bank to report the results upon tinkering with rate on its success on its mandate, that is how does changes in the bank rate’s aid in incentivizing human action. Does the bank action aid human actions, which can enhance human productivity and therefore prosperity or is does it frustrate human action and therefore impede the cause of human productivity?
These are the questions, which its answers are not immediately clear, and no obvious mechanism in place to put the bank policies in accord with public interest.
This is my own views on the bank policy, and it is not financial advice or guidance on monetary matters- do your own research, the only objective here is to entertain and educate.
Genesis 47:15
