Why MPC Reduced Interest Rate
“Now that policy rate is presumably below the neutral interest rate to buttress Nigeria’s stance on expanding the economy, there is no room for an insensible fiscal interaction”.
The Central Bank of Nigeria (CBN) reversed the trend of interest rate hikes on the 24th of November, 2015 in its last Monetary Policy Committee (MPC) meeting for the year in an effort to soften grounds for an expansionary drive. The interest rate was reduced sporadically during and after the 2008 financial crisis to absorb market disruptions caused by the crisis until the end of 2011 where it was maintained at 12% for about 26 months. The benchmark interest rate was increased to 13% in 2014 while inflation crept up well above the apex bank’s target.
The decision to reduce interest rate by 200 basis points to 11% was partly informed by the assertion that the CBN has been involved in unconventional form of monetary policy in an effort to promote increased lending and liquidity. The CBN intervention has properly focused on money rate of interest using control over bank reserves as leverage to influence the pace of lending after the Treasury Single Account (TSA) that drained some liquidity from the economy. Cash Reserve Ratio for banks was reduced from 25% to 20% in a model that monitors injection of unlocked money into the economy. Expectations are in favour of the Federal Government using its power to promote maximum employment, production and purchasing power as a new political consensus.
It is expected to experience a difficult and frustrating market when major policy decisions are made, a relief is that hard markets are typically followed by easier markets. The CBN has opened a lot of “what if doors” in the economy caused by a major shift in interest rate policy. It won’t be totally wrong to say that government’s efforts are progressing towards completely deemphasizing dependency on oil in the long term.
Going forward, the struggle will be to restore discipline into an economy with excess money in supply and a demand pull inflation in the long term. On the other hand, liquidity trap could render the monetary policy ineffective in an economy that looks to benefit from potential rise in interest rates. The effectiveness of this new policy will thrive on the willingness of banks to lend greater amounts, flexibility of short term rates (below zero short term rates) and the credibility of the monetary authority.
By: Korede Ologun, Research Analyst