Besides the close linkage to inflation, anchoring monetary policy in most sub-Saharan Africa
countries to a monetary aggregatehad the advantage of readily available monetary data and a disciplin-ing effect on fiscal policy. In the 1990s, some of the underlying assumptions of a money-targeting framework became increasingly questionable, especially in advanced economies (Box 3.1). In particular, the view that the central bank had full control of the nominal money stock—and that the long-run relationship between money growth and nominal income growth was stable—was widely challenged. At the same time, exchange rate pegs also started to fall out of favor in the face of growing international capital flows and the high cost of potential currency crises.
A dramatic decline in trend inflation has been a major factor in the way monetary policy is conducted in the region. In the 1990s, sub-Saharan African countries hung on to money- or exchange rate-based monetary policy regimes as inflation was still in double digits on average for most sub-Saharan African countries—except those belonging to the CFA franc zone—and closely controlling the money supply was seen as critical for bringing down inflation.4 However in the last decade, the region has seen a trend decline in inflation and its volatility (Figure 3.1), with diminished importance attached by policymakers to changes in the money supply.
In money-targeting countries, inflation declined from 24 percent in 1989–2000 to 10 percent in 2001–12.5 In two of the three inflation-targeting countries (Ghana, South Africa, Uganda), inflation performance was mixed. In South Africa, inflation declined from 10 percent to 6 percent, in Ghana from 27 percent to 16 percent. At the same time, terms-of-trade shocks have tended to hamper the transition to disinflation in several sub-Saharan African countries (Box 3.2).
4 The CFA (African Financial Community) franc zone comprises two monetary unions pegged to the euro: the West African Economic and Monetary Union (WAEMU), comprising eight members, and the Economic and Monetary Community of Central Africa (CEMAC), comprising six members.
5 Excluding the Democratic Republic of the Congo, which experienced hyperinflation in 1993–95.
Figure 3.1. Sub-Saharan Africa: Trends in Inflation, Average Consumer Price Index, 1980–2012
30
980 984 988 992 996 2000 2004 2008 2012
Percentchange
0
1980 1984 1988 1992 1996 2000 2004 2008 2012
Source: IMF, World Economic Outlook database.
Box 3.1. Global Evolution of Monetary Policy Frameworks
The adoption of money targeting by many countries in the mid-1970s followed the collapse of the Bretton Woods system of fixed exchange rates in the early 1970s and a widespread increase in inflation. In the late 1970s and 1980s, many central banks around the world built their monetary policy frameworks around money targeting as an alternative to exchange rate pegs (Goodhart, 1989). Money targets had the advantage of count-ing on rapidly available information, and of becount-ing a useful tool to induce fiscal policy discipline.
In the early 1980s major industrialized countries began abandoning money targeting as unstable money demand, rapid financial innovation, disintermediation from the banking system, and deregulation of financial markets began to weaken the relationship between monetary aggregates and inflation; monetary targeting became increasingly unsatisfactory as a useful nominal anchor for monetary policy. This was followed by the collapse of exchange rate pegs of various kinds in industrial countries—accounting for two-thirds of monetary policy frameworks in 1989—culminating in the Exchange Rate Mechanism crisis in 1992 that helped spur the adoption of inflation targeting by some European countries followed by several emerging markets in the early 2000s. New Zealand was the first advanced economy to introduce inflation targeting in 1989.
By the end of 1990, global inflation was at its lowest since the breakdown of the Bretton Woods system. Many countries brought down inflation to 25-year lows and were in search of a framework to anchor inflation gains more effectively (Mahadeve and Sterne, 2000). Countries in the European Union made a historic shift toward a currency union, while other countries were pushed by currency crises toward greater exchange rate flexibility.
Many advanced and emerging market countries have adopted inflation targeting since then, incorporating key elements of successful money-targeting regimes.
The first real challenge to the credibility of inflation-targeting regimes was the 2008 commodity-price shock and how to integrate financial stability in the inflation-targeting framework after the global financial crisis.
Inflation targets were overshot by most emerging market inflation-targeting countries, but inflation-targeting countries saw inflation rising by less than in other countries. Currency appreciation under flexible exchange rate regimes and a greater degree of central bank independence helped keep inflation in check (Habermeier and others, 2009). Some economists find that inflation targeting, like other regimes in place in advanced economies, did not pay enough attention to asset-price bubbles and their potential impact on financial stability before the crisis, meriting exploration of other monetary policy options (Frankel, 2012). However, many authors argue that inflation targeting will still be needed as “advanced economies work their way through today’s slow growth, rickety banks, and over indebted public sectors” (Reichlin and Baldwin, 2013, p. viii).
3. IMPROVING MONETARY POLICY FRAMEWORKS
Box 3.2. Monetary Policy and Terms-of-Trade Shocks in Sub-Saharan Africa In recent years, terms-of-trade shocks (mainly reflecting food and fuel price shocks) have posed challenges to the conduct of monetary policy in sub-Saharan Africa (2007–08 and 2010–11; Figure 3.2.1):
The 2007–08 Episode
In the 2007–08 episode, average inflation in sub-Saharan Africa increased from 9 to 15 percent, mainly because of an acceleration in food prices from 10 to 20 percent and in fuel prices from 12 to 19 percent. Inflationary pressures quickly abated because of the worsening of the global financial crisis, and interest rates remained low in most sub-Saharan African countries in anticipation of potential spillover effects from the global downturn on the region’s economic activity. The policy advice during this episode focused on accommodating the first-round effects of these shocks.
The 2010–11 Episode
During the 2010–11 episode, the impact on inflation was more varied across the region (Figure 3.2.2).
In countries with formal inflation targeting regimes (for example, South Africa), the inflation impact was largely confined to the first-round effects of higher import prices. In Ghana, another inflation-targeting country, inflation was little changed compared to the year before. However, the picture was very different in some fast-growing countries with floating exchange rate regimes that had kept interest rates low for a prolonged time. The terms-of-trade shock combined with strong credit growth led to significant inflationary pressures in these countries. In several cases, exchange rate depreciation compounded the inflationary impact (Kenya, Tanzania, Uganda). Inflation rates approached or exceeded 20 percent by the fourth quarter of 2011 in Burundi, Ethiopia, Kenya, Tanzania, and Uganda.
Both countercyclical monetary and fiscal policy were pursued in a number of countries but at varying speeds in response to the shocks.
This box was prepared by Yibin Mu.
200
250 Food Price Crude Oil Price
Figure 1. World Commodity Prices,Index (2005 = 100)
100 150 200
Index, 2005 = 100
Food Price Crude Oil Price
0 50 100
2001Q2 2002Q1 2002Q4 2003Q3 2004Q2 2005Q1 2005Q4 2006Q3 2007Q2 2008Q1 2008Q4 2009Q3 2010Q2 2011Q1 2011Q4 2012Q3 2013Q2
Index,
Source: IMF, World Economic Outlook database.
2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2
Source: IMF, World Economic Outlook database.
Figure 3.2.1. World Commodity Prices
Source: IMF, World Economic Outlook database.
Source: IMF, International Financial Statistics.
Note: Zimbabwe was excluded due to hyperinflation.
10 15 20 25 30
month percent change
Sub-Saharan Africa WestCentral EastSouth
-5 0 5
2001Q1 2001Q4 2002Q3 2003Q2 2004Q1 2004Q4 2005Q3 2006Q2 2007Q1 2007Q4 2008Q3 2009Q2 2010Q1 2010Q4 2011Q3 2012Q2 2013Q1
12-m
Figure 3.2.2. Sub-Saharan Africa: Inflation by Region
The approach to more flexible monetary policy frameworks varies across countries in sub-Saharan Africa. Key features of the monetary policy frame-works for 11 countries—for which information is readily available and that represent varied monetary and exchange rate regimes, per capita incomes, dependence on natural resources, and central bank institutional arrangements as of 2013—are shown in Table 3.1. All countries report the use of some form of policy rate, and all but one pay attention to the interbank rate as an operating target.6 Still, 8 out of 10 countries rely on broad money as an intermediate target, and the same number report a floating exchange rate regime.
A few specific observations are noteworthy in Table 3.1:
• Achieving and maintaining low inflation is the primary objective of monetary policy frame-works in most countries (Table 3.1) and in most cases the specific level or the horizon over which it is to be achieved is not defined. Some money-targeting countries also use a policy rate as a complement (Kenya, Nigeria). However, under this regime while money targets may not play a systematic role in monetary policy, the adoption of greater flexibility permits the use of target ranges for monetary aggregates.
• A similar set of monetary policy instruments is employed across all monetary policy frame-works, although the extent to which they are used varies across countries.
• Monetary policy committees are now becoming an integral part of the institutional arrange-ments (Angola, Kenya, Uganda, among others).
This has increased the transparency and com-munication of monetary policy.