Ethiopia: Reconfiguring Pitfalls in NBE's New Strategic Plan

In December 2023, the National Bank of Ethiopia (NBE) released a three-year Strategic Plan, for the period 2023-26. The Strategic Plan contains five strategic objectives, action plans, key performance indicators, and time frame for implementation of each task. If the strategic plan is implemented, it will completely transform monetary policy and financial sector regulation and supervision, marking a significant progress in our recent central banking history.

Although a number of issues are incorporated in the Strategic Plan, I want to shed some light on the issues pertaining to monetary policy. One of the strategic objectives included in the Strategic Plan is ensuring price and external stability, on which the NBE has miserably failed for nearly two decades. The failure of the NBE on its primary task has emanated from the use of outdated monetary policy regime, lack of institutional independence and the existence of fiscal dominance.

The NBE's primary responsibility is ensuring price stability. In the current monetary policy framework, price stability is assumed to be achieved through targeting the growth of monetary aggregates, which is in turn is assumed to be influenced by siring the growth of reserve money along a predetermined path.

The ability of the NBE to influence the growth of monetary aggregates through adjustment of the reserve money has been called into question. Firstly, the NBE has less control over reserve money in the presence of fiscal dominance and other autonomous factors. Secondly, the relationship between reserve money and monetary aggregates has been unstable due to fast monetization of the economy and unpredictable lending behaviour of commercial banks.

Furthermore, this framework is based on the assumption that that there is a stable and predictable relationship between nominal quantity of money and nominal aggregate income. Experience has shown that this assumption is, however, untenable in the face increased monetization of the economy and for other reasons.

- Advertisement -The failure of monetary targeting regime has led many countries to move to a price-based (interest-based) framework. The NBE's plan of introducing a price-based framework is commendable, but caveats should be added to its practicality in the current Ethiopian banking sector context. The price-based framework assumes that the NBE can influence the level of private sector borrowing through the interest rate, set around policy rate, it charges when availing credit to the banking system in times of liquidity needs.

The application of a price-based framework depends on a banking sector functioning on market principles, the ability of the NBE to forecast and manage liquidity, and the existence of analytical capability in setting the policy rate, whose accuracy depends on the quality of the GDP forecast, trend GDP, and inflation projection etc. data...Read more on All Africa

Source: All Africa