Government should aim to stimulate the forces of enterprise and competition by relaxing the constraints imposed by over-restrictive regulations, by eliminating specific controls that distort the workings of the market mechanism, and by creating an environment conducive to growth. In the government sector, emphasis must be in the inter-relationship of monetary, debt management, fiscal, credit agency control in their influence on the levels and composition of demands in the economy. A coherent combination of measures is essential to an effective national economic policy.
Control over conditions governing the quantity of money is inevitable in a modern industrial society. The concept underlying the general monetary control is relatively straightforward. Monetary restraint reduces the availability of credit and increases its cost; and these retard the flow of expenditure, income, and output. Monetary ease, in general, has the opposite effect on credit, and thus encourages expansion in these flows. A change in monetary policy may take the form of positive action such as open market sales, increases in reserve ratios, or changes in discount policy. But a shift to a restrictive policy often takes the form of failing increase in reserves in the face rising demand for credit. The central bank may attempt to restrain economic activity through open market sales of treasury bills. These sales will reduce net bank reserves, cause the fall of money supply, decline the price of government securities and increase their yield; cause the fall in value of total money assets; reduce the overall liquidity of financial portfolios; and reduce the ability and willingness of banks to lend.
Monetary restraint causes a reduction in the willingness, and ability, of nearly all institutional lenders to meet all the credit demands made on them. It also affects the desire of the public to spend, through the changes it brings about in the rate of interest and in the market value of income-yielding assets, and liquidity of the public wealth holdings.
Studies of the actual behavior of business investment and interest rates indicate that some kinds of investments are sensitive to changes in the interest costs. Changes in monetary policy have other indirect effects on the rate of expenditure than through their effects on cost and availability of credit. An announcement of recognition of a change in monetary policy may contribute to changes in attitudes and expectations as to the future rate of growth of demand, sales, income, profits, and the future level of prices. These attitude changes may have a substantial effect on investment expenditures. On the other hand, an expansive policy would tend to increase the net reserve position of member banks, to increase the prices and reduce the yields on treasury securities to improve the liquidity of banks and other lending institutions, to enhance the wealth position of all holders of financial assets, and to increase the money supply.
Combination of Effects
The pervasive and cumulative combination of a number of small effects can make flexible monetary policy a useful instrument on stabilization policy. Monetary restraint on the upswing will be more effective if:
The effectiveness of monetary policy on the downswing will be increased if:
Monetary policy can be used in precisely the circumstance when the discretionary fiscal policy changes, because of its irreversibility and the possibility of changing policies by small steps, should not be used because the need for so powerful an instrument is not yet clear.
Long-run Monetary Policy
Long-run monetary policies must provide a monetary climate consonant with an adequate and sustainable growth rate and overall price stability. This climate should permit the banking system to expand its loans and investments and hence the supply of money at a rate commensurate with the economy’s underlying growth potential. The average rate of growth of money supply should be consistent with the continued maintenance of high employment at stable prices and adequate economic growth.
Open market operations should be the normal instrument of general monetary policy. The CBN should influence, directly, the structure as well as the level of interest rates in pursuit of contrary-cyclical monetary policies and should deal in securities of varied maturities.
The role of fiscal policy in economic stabilization is far better understood today than it was during the early years of Nigeria’s independence. The challenge for now is to improve the use of fiscal tools to smooth lesser fluctuations of prices, output and employment, and to promote economic growth. Unfortunately, in the economy, neither the size nor timing of our fiscal policies has been appropriate to move the business cycle. With a given oil revenue and expenditure structure, changes in total income and output result in automatic changes in revenue yields and in certain outlays by the government. As international oil demands fall, national revenue falls too; and vice versa. These are known as automatic economic stabilizers. However, it is very difficult to estimate the effectiveness of existing automatic stabilizers. Recent experiences with economic downturns during the military era raise the questions whether automatic stabilizers can and should be strengthened to play a greater roll in reducing the amplitude of cyclical fluctuations.
Two possibilities that may be considered in strengthening the automatic stabilizers include,
The most attractive possibility would be to provide the first-bracket rate of the personal income tax be reduced by a specified number of percentage points whenever these economic indicators suggest deficient demands, and conversely the rate would be automatically raised to its old level when indicators reveal a restoration of adequate demands. Similarly, the first-bracket rate of the personal income tax be raised by a certain percentage point when indicators suggest excess demand, and be lowered when the excess is eliminated.
The formula approach would ensure that changes in tax rates would work both ways. If rates are cut in economic recession because of the formula adopted, they will be raised again during economic upswing. This will avoid any bias that might arise from discretionary action.
This requires speed of decision and effects, and can only be successful if temporary and reversible fiscal measures for stabilization purposes are disassociated from permanent and structural changes. A technique where taxation and expenditure policies can be applied more flexibly is desired; and the first step in this direction should be a sharp demarcation between short-run cyclical changes and long-run structural changes.
Two major objections commonly raised against discretionary measures are:
Those responsible for determining fiscal policy must chart their courses between reducing consumption and increasing savings to free resources for capital formation, and speeding up growth through capital formation by encouraging a high rate of consumer demand. Unfortunately, none of these positions are applicable to conditions in the real world.
When economic conditions are such that unemployment is at minimal level, and when growth may be accelerated by raising supply of new investible funds through either increased private savings, primary reliance should be on increasing government surplus rather than changing the tax structure. Also, when conditions are such that a higher level of consumption is required, reliance should be on reducing the level of tax rates rather than changing the composition of our tax structure.
To shore up investment, government should consider minimizing tax deterrents to capital formation like accelerated depreciation, or tax credits on new investments. Also, planning and execution of public capital projects should be adapted for a farsighted and sustained investment program. National, state, and local legislators should explore projects of particular growth importance and enact 5-year expenditure programs for such projects. These governments should also set up oversight committees to monitor the projects to ensure compliance to directives and execution to standards. This will minimize or eliminate wastage. At the end of the day, everyone will be better off.
Oti & Associates