It is worth remembering that when the Central Bank of Ghana (BOG) is making economic decision such as setting policy rate, there would be lots of other events and policy decisions being made in other economic jurisdictions. Not far-off mention, include changes in fiscal policy by foreign governments, changes in world oil prices or the erratic pendulum of exchange rate that is frequently seen in recent times. The assumption of ceteris paribus is rarely applicable in such instances.
The decision by the Monetary Policy Committee (MPC) in the just ended monetary policy meeting is expected to affect key macroeconomics indicators in a number of ways. Does this decision present palpable antidote to the country’s economic headaches? Attempt to delve into how the drop in policy rate may affect key economic indicators within the economic boundaries of Ghana makes a great deal of sense as concerned participants. A careful look at the below time series data of the trend of MPR for the past five years draws some interesting performance possibilities.
Graph 1
From the graph above, monetary policy since 2013 has gradually increased over the years up unto 2017 where the rate began to drop at a decreasing rate.
To begin with, a drop in policy rate has a potential influence on aggregate demand, output and prices of goods and service in our economy. This occurs through what economist call the transmission mechanism. Aggregate demand as well as inflation in our economy can be greatly influence via lending and borrowing rates charged in the financial markets. When the base interest rate of most Banks goes up, it is typical to see an increase in the charges on loans and the interest offered on savings. When this occur businesses and individual investors are discouraged from taking out loans to finance projects. This becomes a disincentive to investment and an incentive to savings. Savings culture is therefore encouraged in such a situation which intend depress aggregate demand. Conversely, in this era where policy rate dropped from 23.50% to 22.50%, it is expected that the base rate of Banks, although historically banks have been reluctant to do so, would fall to encourage more borrowing by investors. This will stimulate demand and output in the economy at large. When businesses are able to acquire loans at a lower interest rate from the financial market, it is expected that productivity would increase at large. An increase in production would then increase Ghana’s Gross Domestic Product (GDP).
More so, the increased in productivity creates the avenue for more jobs in the country. We therefore anticipate an increase in our employment rate going forward since the expansion of businesses is believed to create most employment avenue for Ghanaians. Demand for labour would then be on the rise. A better employment rate is expected to better the standard of living of Ghanaians which would intend increase the demand for goods and services.
If commercial banks indeed borrow from the central bank, then lending rate is expected to fall with a drop in MPR. However, this is not the case in reality. A drop in MPR is expected to boost lending which is expected to in-turn increase productivity since lending is a major cost factor in production. When productivity does not grow to meet demand, what would ensue is that the increase in money supply would set-off high inflation in the long run. We can therefore conclude that a reduction in our MPR is just a step towards improving economic growth and development but not entirely a panacea. Other variables such as productivity, labour supply, technology and the like must also be considered as such. A stable inflation rate helps improve an economy. There is therefore a need to analysis the trend of inflation vis-à-vis MPR to know how these two variables have fared over the past five years.
Graph 2
Milton Friedman once said inflation is always and everywhere a monetary phenomenon.Using a time series data from 2013 to date, MPR and Inflation move parallel. As inflation increases, MPR also increases and vice versa all in showing of the effort to tame the rate at which more money runs after few goods. This thus follows that the current drop in MPR to 22.50% is a move to mirror the downward inflation trend in recent time, although some have questioned the significance of the MPR drop to indeed drive down lending rate on the market. This however stands plausible if the drop effectively spurs productivity. When this is achieved overtime, prices of outputs would stabilise and Ghana would experience reasonable economic growth in the long run. It is however cautioning to note that, should output remain subdued, impact of the policy rate drop would be negligible.
Albeit, monetary policy is a very essential tool in controlling money supply in the country, there is a need for the implementation of other critical economic policies to boost growth.
In summation, reduction in the policy rate is in the right direction to help stabilise Ghana’s economy and help improved economic growth at large although it would take some time to experience the full effect on real GDP. However, we as a country should always remember that Monetary Policy is not a panacea as Ben Bernanke once said hence the need to consciously employ a mix of tools to work together in fixing of the economy and propel growth.
By :Rita Fosu Brefo
Banker
ritafb@mail.com