By Lang Conteh
On 29 August, 2023, the Central Bank of The Gambia announced its key Monetary Policy Decision which raised the Policy Rate (MPC Rate) from 16 percent to 17 percent. This policy move has been the culmination of a series of rate hikes that started in the aftermath of the covid-19 pandemic and the Russia-Ukraine war, which events induced global supply chain shocks on the world economy with high inflationary consequences for small open economies like The Gambia. Thus from an MPC Rate of 10% in May, 2022, to 12% in September 2022, and 13% in December 2022, the current rate of 17 percent is by all intents and definitions a tight Monetary Policy stance, a course of action undertaken by the Central Bank to curb down a rising inflationary trend, by contracting spending in the economy that is seen to be accelerating too quickly or too fast.
As an act of public service, and through the auspices of GAMNATT, I intend to simplify for our readers and everyday Gambians, the implications of this Monetary Policy measure, and explain in simple terms the decision process and how it impacts on our daily lives and the Gambian economy at large.
The Central Bank of The Gambia’s principal mission and mandate as the monetary authority is empowered by the Central Bank of The Gambia Act as revised in 2018, to ensure and maintain the price and exchange rate stability of the Gambian Currency, the Dalasi. What this means for the ordinary Gambians is that, even the poorest of Gambians who wake up with just a hundred Dalasi can be sure that when they go to the market today and tomorrow, they will be able to buy their basic food items at the same prices, without even much thought. In fact, stable prices, is the most important and most pervasive instrument of social and economic justice to redistribute wealth and ensure everyone’s basic survival in any economy in the world. It is the catalyst for more consumption, more production and more development – this is called aggregate demand. I will explain later.
When the general level of prices are unstable and on the ascendancy, that is on a rising trend, inflation sets in, and the burden of sufferance and survival is felt more by the poor and vulnerable low income families and working class population segment, whose purchasing power is eroded and diminished because they can no longer afford to buy much and the same, from the same D100. A general increase in the prices of goods and services, especially prices of basic food items, cost of household rents, fuel and electricity: this phenomenon is always referred to as inflation, the number one public enemy to the economy, and to the Central Bank.
In an inflationary environment, unevenly rising prices inevitably reduce the purchasing power of majority of Gambian consumers, and this erosion of real income is the single biggest cost of inflation, because it directly reduces aggregate demand which comprises of total spending in the economy: i.e. the sum of government expenditure, private consumption expenditure and investment in the economy. It follows logically that when aggregate demand falls, hence the level of investments, savings and employment also fall. The economy contracts in a nutshell.
Inflation also distorts purchasing power over time for recipients and payers of fixed interest rates on assets. A corollary to inflation, and even more devastating, is inflation uncertainty, which refers to a situation that is not predictable in terms of future prices, and consumers and investors are unable to predict whether the inflation rate will rise or fall.
In times of high inflation, there is often political pressure for its reduction mainly by monetary policy actions. Under these circumstances, future monetary policy will be unpredictable for the public, and therefore uncertainty about inflation will rise further. This speculation about future prices means that firms will wait to make investment decisions, delay major projects or defer hiring until the economy’s likely future path is clearer. It might also slow down the re-allocation of resources to more productive uses for similar reasons because of credit rationing by financial markets. Household consumption decisions are also affected by uncertainty due to speculation.
This in short summarises the devastating consequences of inflation on the national economy, and on households, hence the need for a Monetary Authority invested with all the necessary powers to fight it.
I. CBG monetary policy framework
In order to tame inflation and keep the price level stable, the Central Bank of The Gambia (CBG) adopts a monetary policy framework that focuses on targeting reserve money as the operating benchmark, and broad money as the intermediate target. This means that The Bank sets targets for key monetary aggregates in line with its inflation objective of 5 percent in the medium term.
The emphasis is placed on keeping the growth of reserve money on target as estimated in the Financial Program agreed with the IMF staff mission. This simply means that the Bank cannot just print money to finance Government’s fiscal deficit beyond an established threshold, which is agreed upon within the context of any financial program with the IMF.
Under a monetary targeting framework, the changes in money supply are considered as primary causal factors affecting price stability. In general, two major definitions of monetary aggregates are considered in analyzing monetary developments in The Gambia. The first is ‘reserve money’ consisting of currency issued by the Central Bank and commercial banks’ deposits with the Central Bank. This is also called base money or high-powered money, as commercial banks can create deposits based on reserve money which are components of a broader definition of money supply, through the process of creating credit and deposits. The second is broad money defined as the sum of currency held by the public and all deposits held by the public with commercial banks. In the case of The Gambia, the most appropriate monetary variable to analyze the relationship between the money supply and the general price level is the narrow definition of money supply, which is reserve money.
Hence, in order to contain the level of liquidity in the system the Bank conducts open market operations (i.e. weekly auctions of Central Bank Bills and Government Treasury Bills of mostly 90 days maturities), which continues to be the major tool for liquidity management. It must be emphasized that the effectiveness of mopping up liquidity depends on the level of sterilization of proceeds to ensure Government doesn’t have recourse to using these monies.
Other complimentary policy tools include foreign exchange interventions and the statutory reserve requirement ratio which could be adjusted upwards to constrain commercial banks’ lending capacity. What this implies is that commercial banks also have the power to increase money supply through their ability to take deposits and make loans.
Thus monetary policy can also be implemented through the Cash Reserves Ratio (CRR), as a tool to regulate the money supply and control inflation. Here’s how CRR works: CRR is the percentage of a bank’s net demand and time deposits or liabilities (NDTD) that is required to be maintained as liquid cash reserves with the Central Bank. Since these reserves are maintained with the Central Bank, the commercial banks cannot use these cash to make loans, thus reducing money supply in the economy. The percentage of cash required to be kept in reserves as against the bank’s total deposits, is called the Cash Reserves Ratio. Banks can’t lend the CRR money to corporates or individual borrowers, and banks can’t use that money for investment purposes either. There is also a fiduciary consideration in that the CRR also acts as a prudential insurance of deposit liabilities.
When the reserve requirement increases, the money supply tightens which leads to a lower multiplier effect. This results in banks to lend out less money because the option will have some limitation based on the size of the reserves. It means that if the reserve ratio is higher, then the money multiplier will be lower and the banks need to keep more reserves. As a result, they will not be able to lend more money to individuals and businesses. Similarly, a lower reserves ratio results in a higher money multiplier that allows a lesser amount of money to be kept with the Central Bank as reserves, and therefore more lending opportunities to the public.
The money multiplier is defined as the maximum amount of new money created by banks for every Dalasi of reserves. It’s calculated as the reciprocal of the reserve requirement ratio set by the Central Bank.
In September 2018, the Central Bank added to its toolbox an interest rate corridor with the objective of improving liquidity management and the transmission of the effects of monetary policy. The interest rate corridor consists of overnight standing lending and deposit facilities. The Central Bank conducts Open Market Operations (OMO) within the corridor of interest rates formed by its policy rates, that is, the standing deposit facility rate, and the standing lending facility rate to achieve the intended inflation path. Policy rates are periodically reviewed and adjusted appropriately, if necessary, to guide the interest rate structure of the economy with a view to achieve the desired path of inflation. The Standing Lending Facility (SCF) is an overnight lending facility that provides funds to commercial banks at a predetermined interest rate to cover end-of-day liquidity shortfalls. The Standing Deposit Facility (SDF) is an overnight deposit facility that allows commercial banks to place excess funds at the Central Bank for remuneration at a predetermined rate. The rates are subject to review by the Monetary Policy Committee (MPC) of the Central Bank.