Aligning monetary, fiscal policies for robust financial system

BY KADIRI ABDULRAHMAN

Monetary and fiscal policies are considered crucial for establishing a robust financial system; hence the need to align them, especially in Nigeria.

Experts believe that when these two major macroeconomic levers work in harmony, they create a stable, predictable economic environment that allows financial institutions to perform their core function of intermediation effectively, while minimising systemic risk.

To this end, the Central Bank of Nigeria (CBN) recently invited stakeholders to map out ways to effectively align both policies in its recent seminar for finance correspondents and business editors.

Monetary Policy, managed by the CBN, uses tools like interest rate changes and open market operations to control money supply and maintain price stability.

By adjusting interest rates, the CBN can influence borrowing, spending and investment decisions, impacting overall economic growth and inflation levels.

Fiscal policy, on the other hand, refers to the use of government spending and tax policies to influence economic activity.

Managed by the government, fiscal policy focuses on increasing public spending, reducing taxes or a combination of both to stimulate the economy during a downturn.

Fiscal policy may also involve reducing spending or increasing taxes to cool down an overheating economy.

While fiscal policy primarily targets aggregate demand through changes in taxation and government spending, monetary policy influences money supply, borrowing costs, and credit availability.

Experts say these two policies, working in tandem, can help achieve macroeconomic stability and avoid situations like hyperinflation or recession.

They say coordination between fiscal and monetary policy becomes crucial when aiming for overall economic stability.

It is their contention that without coordination, fiscal expansion by the Federal Government could lead to excessive inflation if not accompanied by monetary tightening.

The experts also say that restrictive fiscal policies might need to be offset by accommodative monetary measures to ensure that growth is not compromised.

They posit that the primary benefit of the alignment is that it prevents conflicting signals and policy pushback, which can introduce volatility and uncertainty into financial markets.

A renowned Economist, Prof. Ken Ife, described a robust financial system as one that is resilient to domestic and external shocks.

Ife, the Chief Economic Strategist, ECOWAS Commission, said that such a system should be able to efficiently intermediate resources, protect consumer deposits, maintain market integrity and provide the necessary capital for economic growth.

“This involves managing and eliminating systemic risks created by the historical tension between the CBN and the Ministry of Finance.”

He said that the major threat to the stability of the Nigerian financial system and fiscal stability was fiscal dominance.

According to him, fiscal dominance occurs when the fiscal authority’s large, chronic borrowing needs (budget deficits) constrain the independence and effectiveness of monetary policy.

“The CBN is always compelled to finance government deficits via Ways and Means Advances.

“This injects massive, non-sterilised liquidity into the economy, directly leading to high inflation and making the CBN the primary cause of instability it is mandated to control.”

Ife said that the role of the CBN was to ensure price stability and oversee the soundness of the financial system.

He said that its tools must be used consistently and predictably to inspire and maintain investor confidence in the financial system. The economist urged the apex bank to prioritise its legal mandate of price stability.

“Achieving sustained disinflation is the most critical contribution to financial system health, as high inflation distorts pricing, creates negative real interest rate, discourages savings and undermines long-term investments.

“Monetary policy decisions must be made solely based on economic data, free from political pressure of short-term fiscal needs,” he said.

The CBN Governor, Mr Olayemi Cardoso, said that it had become clear to the monetary and fiscal authorities that the most efficient and effective way to achieve their objectives is through partnership and collaboration.

While presenting a communiqué from the 303rd meeting of the apex bank’s Monetary Policy Committee, Cardoso said that the collaboration had become obvious to the rating agencies.

“You will see collaboration in operation in many spheres, including the outcomes of the rating agencies.

“We are very fortunate that we have a position of the Permanent Secretary of the Ministry of Finance as a standing member of the MPC.

“That also is something that we do not take lightly, given that it is the leadership of the fiscal authority that sits here.

“Also, further down the line, across different parts of both the CBN and the Federal Ministry of Finance in particular, we have joint committees that meet regularly and work together.”

Cardoso said that the move to inflation targeting by thc CBN required the utmost collaboration between the fiscal and the monetary authorities.

“In fact, some would argue that you are not likely to succeed if you are unable to collaborate effectively.