Indicators In The Nigerian Money Market
The money market variable contending for the choice of indicator variable are; the rate of interest, commercial bank borrowing from the central bank and free reserves. We will discussed each of them in turn.
- Rates of interest – An increase in the rate of interest is usually interpreted as a move towards a restrictive monetary policy, and visa-versa. The major advantage of the rate of interest is that information about it is readily obtainable. But the major shot coming is the central bank policy. Change in public expectation about the rate of inflation and fiscal policy both the rate of interest.
- Commercial banks borrowing at the central bank – Where central bank is pursuing a tight monetary policy, commercial banks are driven to the central bank discount window. Thus an increase in bank borrowing can be regarded as an indication of tight monetary policy. But it is a misleading indicator, since it can rise by virtue of the pushing of market rates of interest above the central bank rate. If the rise of the market rate of interest is due to factor other than central bank action borrowing is a misleading indicator of the thrust of monetary policy.
- Free Reserves – These are defined as the difference between excess reserve and commercial bank borrowings from the central bank of the country in question. When they are rising, it is argued that monetary policy is expansionary, and vice versa. The use of this variable is that it summaries in a single statistic and strength of the demand for bank loans relative to the ability of banks to meet that demand.
Thus, when the demand for loan increase, banks down their excess reserves and resort to borrowing from the central bank. Consequent upon this their free reserve decline, and this suggest tight monetary policy. The reserve situation of decreases in the demand for loan is reflected in an increase in free reserve and indicates an expansionary monetary policy.
However, it has been argued that free reserves are a poor indicator of monetary policy. This is because they can be influence by factors other than central bank action. Such an increase in the rate of interest can affect borrowing and consequently free reserves.
In addition, a rise in the rate of interest can affect excess reserves and hence free reserves. Thus, a change in the rate of interest that is not brought about by central bank action but affects free reserves will make the latter a poor indicator of monetary policy.
Money Aggregate Indicators
- Money Supply – This is usually regarded as the best indicator because of the link between it and the ultimate goals. Therefore, when we observe the behaviour of the money supply, we get an idea of the direction and impact of monetary policy. But money supply has its own shortcomings too. It can respond to factors other than those by the central bank. For example, interest rates and other variables affect components of money supply and even the monetary base itself. In addition, there is the small problem of defining money supply.
- Bank Credit – Bank credit consists of the earning assets of a bank (in essence loans and investments). It is usually argued that the composition of bank credit is a good indicator of monetary policy. For example, a growth in business loans is more expansionary than a comparable growth in some other assets. This too not without its own shortcomings that are much the same as for the money supply as an indicator.
- Reserve Aggregates – Two of these can be identified as the monetary base and total reserves. The advantage of reserve aggregate is that are more directly under the control of the central bank. The monetary base, as we saw in our discussions on the monetary policies of the Nigerian financial sector the reserve aggregate is made up of reserves from banks and currency in circulation. It is linked, through the money multiple and the various ratios, to the money supply, and it is directly under the control of central bank.
Total reserves are the monetary base less public holding of currency. It is linked too to the money supply. A survey of empirical work in this area tends to support the use of the monetary base as the best indicator of monetary policy. But as a scholar known as Luckett argued which ever indicator one chooses depends to a considerable extent on which monetary theory one chooses. It is unlikely that the indicator problem will resolved until the large problems of monetary theory are resolved.
Target Of Monetary Policy
In the course o this article we have discussed and argued that the existence of a lag, uncertainty and information gaps creates problems in the conduct of monetary policy. One of such problems is the fact that the effect of currency policy on the ultimate goals is not immediately and directly observable. Hence, the effect of a current policy can be noticed only after some time.
In the absence of lags and uncertainty, the impact of policy works directly between the policy instruments and the ultimate goals. But with lags and uncertainty, the link is an indirect one-one that works through some kind of intermediary to the ultimate goal or objective. Since the central bank’s view is blurred by the lags and uncertainty that exist between its instruments and goals, it has to resort to the use of another variable that is not only observable with little or no lag but whose behaviour approximates to that of ultimate goal whose value can always be set as a desired level.
We want to refer to this variable as the intermediate target. Presumably, then if the target variable attains the desired level, the ultimate goal too will attained desired value, because of the link between the intermediate target and the ultimate goal. In the words of Brunner and Meltzer. The target problem of choosing an optional strategy or strategies to guide monetary policy operations in the money markets under the conditions of uncertainty and lag in the receipt of information about more remote goals of policy. For a variable to play the role of the intermediate target, it must have certain characteristics;
- The central bank should be capital of affecting directly and in the right magnitude the variable chosen as the target variable.
- The central bank should be able to neutralize the effect of any change on the target variable that is not related to policy.
- The target variable should be related in an unambiguous fashion, to the ultimate goals.
- Conclusively, such a variable must be easily measurable with little or no lag.
We have argued above that, with the presence of lag and uncertainty, the need for an intermediate target is obvious. But what is not obvious is what these targets should be. Should they be monetary aggregate or interest rates? Or should they be a mix of two? Economist have developed rules of thumb for choosing a monetary aggregate and interest rate as the intermediate target. The rest of this section surveys the approach adopted in such studies.
A comparison of VAR has shown that their relative sizes depends on the relative various disturbances terms in the IS and LM curve (in essence o2v and o2U) as well as on the size on the structure parameters. Where, for example, there are large unforeseen fluctuations in liquidity preference, the LM schedule will shift, causing deviations in the level of income, and they money supply target will not work.
The conclusion that one can draw from this is that the choice of money versus interest rates depends upon thee stochastic properties of economy (in essence the source and magnitudes of random disturbances) and not just upon its structural coefficients. A survey of empirical studies that has been done on this issue suggests that a money supply target is to be preferred to an interest rate target. The next question that we want to address ourselves to is the indicator problem.
The indicator problem involves the choices of a variable as a guide, to tell us how easy or tight monetary policy is? The problem with the target variable is that it is in itself an endogenous variable, in the sense that it belongs to the financial system. Change may occur in it that are induced by policy? The point that is being made here is that the observed changes in the target variable (which we call total effect) can be decomposed into two; a policy induced effect and an exogenous effect.
In a situation like this, it is necessary to adopt another variable that is capable of extracting or separating the policy induced competent of the total effect. Such a variable, which gives an objective indication of the thrust of monetary policy, is called the indicator variable. It is expected to inform the monetary authorities and the public of the direction and degree of the current posture.
Monetary policy of any country is usually characterized by the tight (or restrictive) on the hand, or expansionary (or easy) on the other. A tight or restrictive monetary policy is one that is expected to lower prices and soften business or employment conditions. An expansionary or easy monetary policy is one that is expected to stimulate output and employment and push up prices. The role of the indicator variable is to give an unambiguous indication of the thrust of thrust of monetary policy to be able to say precisely whether it is easy or tight. A variable that will play this role must certain characteristics.
- Anybody observing the variable (be it the public or the monetary authority) should be able to make an unambiguous statement about the direction of thrust of monetary policy; that is, it should be able to say whether the policy is tight or easy.
- Such a variable should be largely under the control of the monetary authority, so that changes in the variable reflect only changes in the actions of the monetary authority.
- Movements in the indicator variable should be highly correlated with the ultimate policy goals. For example, if the indicator shows that monetary policy is easy, we should expect an increase in output, employment and price.
- Finally, the indicator variable must have a theoretically and empirically unambiguous relationship (mostly in terms of sign) with the intermediate target variable.
Which variable, then qualified as the indicator variable? The rest of this sector is devoted to a consideration of the candidate variable for the choice of indicator of indicator and to a review of an analytical device that can be used to select the indicator variable among the contending candidates.