Bank of Tanzania’s Game-Changing Policy Shift: A New Dawn for Economic Stability

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As announced on the 3rd of January 2024, the Bank of Tanzania’s plan has moved from its traditional policy framework of managing the quantity of money to an interest rate framework. As stated in the bank memo, such implementation aims to achieve the following:

  • Efficiency,
  • Effectiveness and
  • Resiliency

Although not that explicitly, that is the message I gather in the A4 document. Simply put:

The efficiency objective will ensure that the bank delivers this interest rate control without imposing excess cost in terms of time or money to all users, and without soliciting any inconvenience expenses from the central bank.

The effectiveness requirement is to ensure that the framework should be effective in transmitting the policy rate to the broader economy and financial markets. Thus, this rate set by BoT will the base rate for all other interest rates.

The last objective of the policy shift is to guarantee resilience, which means that this shift should work under a broader set of scenarios. As stated, it can be used to stabilize the economy during recession (rates should be decreased) and expansion (rates should be raised). The memo also highlights that this rate will move in line with other policies such as fiscal policy to guarantee its effectiveness.

The motives for the bank shift could be the increasing economic turbulence globally which have been ongoing since COVID-19 pandemic and the dual wars in Ukraine and Middle East. Under this scenario, there is no pre-existing playbook that the bank can use to stabilize the economy and, of course, the incentive to search for new tools.

Read related: Tanzania’s Exchange Rate Policy: IMF Urges Greater Flexibility for Economic Stability.

In world of rising uncertainty and recurring economic and political shocks, it is judicious for BOT to adopt such a mechanism, which help it to adapt and respond quickly to these changes. Agility and resilience will definitely be a competitive advantage in these choppy environments. Although it is not immediately clear, I think Mr. Tutuba is in the money on this one.

From the investor’s point of view, the growing influence of the central bank in the management of rates is going to have overreaching consequences on stocks and fixed-income returns and will likely only reflect in the wealth effect in the long term rather than the short. Investors will do well to study the history of the Bank’s policy shifts worldwide to draw similar lessons. Such view and take is a worth exercise.

Prominently the global uncertainty caused by war and the pandemic have caused huge supply shocks ranging from supply chain disruptions, undermined labour force participations, which have also coincided with other structural shifts in globally. All these have accelerated the need for change in monetary policy for many economies.

Some of these structural changes are climate change, energy transitions, a deepening geopolitical divide, and the fragmentation of the global economy into competing blocs. These have resulted in trade and investment restrictions between countries and potential challenges to regional integrations. All these conditions will have far-reaching consequences for the inflation dynamic.

Few economies including Tanzania have experienced a mild episode of FX shortages and rapid price swings in imported goods such as fuels and consumer goods. Other economies in the region are still not out of the woods with their debt interest payment dues and reserves shortages. In times like these, prudent macroeconomic policies are invaluable.

Read related: A Review: Tanzania’s Resilient Move to Interest-Based Monetary Policy.

The old adage of “the dollar is ours but is your problem” remain valid today and so long as nation do not have a better substitute, they will have to work overtime to remain liquid in these hard currencies. Gold purchase was my previous article- titled Bank of Tanzania goes Gold shopping-which explain the rationale.

So what are the Pros and cons of the policy shift; few there are!

The Quantity of Money Framework (Old Stance)

For those less initiated in the lingua franca of economics, the quantity of money framework is premised on the assumption that changes in the quantity of money cause changes in its purchasing power, as measured by some price index, such as CPI. The biggest critique of this framework is that it lacks the link between aggregate output and employment.

For example, speed- the quantity of money framework as monetary policy transmission mechanism is slow, therefore often less effective in harmonizing the economy in the event of any deviations arising from either endogenous or exogenous shocks. There is some evidence of the bank policy working, looking at its unannounced move towards single digits in its treasury paper issuance, which has helped to direct capital in other investments and reduce the liquidity drought, or could it just be the January effect? It will be interesting to monitor those premia throughout the year.

Another interesting challenge the bank faced using money supply as the policy is that money supply is not only a crucial determinant of long-run inflation in the economy but also a strategic variable in the bank transmission mechanism, which price level dynamic in the long run and income and employment dynamic are linked to policy actions.

Also, read Monetary Policy: Tanzania’s Adoption of Interest Rates.

In 2024, many economies, including Tanzania, are expected to operate in a world with competing policy (monetary and fiscal policy) in a high-debt, high-interest rate world. Stable public debt dynamics around a well-defined steady state are a precondition for ensuring price stability when the central bank uses interest rates as its policy instrument and public obligations are nominal (Woodford, 1994).

However, the theory is clear on policy preference between fiscal and monetary. Monetary policy is superior when it comes to implementation. For example, discretionary monetary policy can be executed more rapidly (wraps speed during COVID- see the data on the growth of money supply then) than fiscal policy can.

Suppose you have sat in any economic class during the macro session. In that case, you will recall that monetary policy is much less subjected to implementation lags compared to fiscal policy. If not go back to your notes and of course, you can always read Taylor (2000) and Fontana (2009) on the subject. Actually, Taylor (2000) expounds broadly on the limitations of fiscal policy as a policy tool during economic cycles.

The fundamental assumption regarding quantity of money framework implemented previously by the bank was based on the assumption that it does gear the monetary policy to the pursuit of money-growth targets. However, there is no sufficient causative evidence to validate this position, which could explain the bank shift away from it. Moreover, the enjoyed speed of monetary policy during COVID-is now becoming costly as inflation keep raging in advance markets.

The expectation is that this adoption will enhance all three benefits of the framework, and all financial markets will be in sync with the BoT policy rate, which, of course, will create credibility in the economy, both locally and globally. After all, accommodative monetary policy has often been used as a moderating tool to drive economic growth, especially when there is an upsurge in public investment spending. From this position, it is hard to fault Tanzania in government investment spending.

It has resulted in short-term stable growth and will likely increase productivity capacity in the long run. The Central Bank, as a government banker, have results to show. Even the move to buy gold as an FX volatility mitigation move, although marginal currently, might just be a golden bullet in the future. Yet, policy asymptotes are complex to forecast, and this one is no different. The economy does not respond symmetrically to policy changes. Therefore, we should expect some before the effects of the change are pronounced in other economic activities and data.

Catch up with Tanzania’s Battle Against Inflation: Strategies, Impacts, and Economic Outlook.

From the literature, policy choices of central banks vary depending on the nature and structure of the country’s economy; therefore, there is no one-size-fits-all. In fact, its policy framework shift is risky despite all its merits. However, as the BOT memo explained, the policy shift was adopted because it fits well with the Tanzanian economic context and the bank mandate, which is to stabilize prices (manage inflation) and promote long-term economic growth.

Moreover, of course, the rather odd comment given that they are doing it because the others in the region have done so. Nevertheless, the document, though not explicitly, seems to suggest that the Bank of Tanzania’s ability to supply liquidity without losing interest rate control is also suitable for maintaining financial stability.

Whether the Bank of Tanzania’s dual mandate of price stability and economic growth is an achievable goal remains to be seen, for it will require the bank to report the results upon tinkering with the rate of the success of its mandate, that is, how changes in the bank rate’s aid in incentivizing human action. Does the bank’s action aid human actions, which can enhance human productivity and, therefore, prosperity or does it frustrate human action and, therefore, impede the cause of human productivity?

These are the questions whose answers are not immediately clear, and there is no obvious mechanism in place to put the bank policies in accordance with the public interest.

This is my own view on bank policy, and it is not financial advice or guidance on monetary matters—do your own research. The only objective here is to entertain and educate.

Genesis 47:15

Ezekiel Lengaram is a Researcher in Economics at Wits University. My teaching and research focus are on the theory of Macroeconomics, Computational Economics and Applied Computational Mathematics

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Rutashubanyuma Nestory
Rutashubanyuma Nestory
1 month ago

And when money failed in the land of Egypt, and in the land of Canaan, all the Egyptians came unto Joseph, and said, Give us bread: for why should we die in thy presence? for the money faileth.
Genesis 47:15 KJV

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