Central banks and the conduct of monetary policy have often been viewed as impenetrable mysteries, understood only by the limited few who somewhere along the way gained access to an exclusive club.Even well-informed citizens will find it difficult to think clearly about many economic issues and debates without having at least an approximate understanding of what central banks do.As part of the 12 part inflation series I have had to cover Monetary and Fiscal Policies mainly due to Zimbabwe's now infamous Quasi-Fiscal Activities (QFA)being carried of by its central bank. These activities due to their nature as unbudgeted off-balance sheet expenditure have been inflationary since they have been funded through printing of money.

Monetary policy refers to any of a number of government measures undertaken to affect financial markets and credit conditions with the ultimate objective of influencing the overall behaviour of the economy. Monetary policy is the responsibility of the Central Bank that implements its policy decisions largely through its ability to alter the money supply.Any excess money growth will likely result in inflationary pressure.

Fiscal policy is the use of government taxing and spending powers to affect the behaviour of the Economy .Fiscal policy also refers to government action to change the total or composition of revenues and expenditures in order to manage the growth of demand in the economy .The economy's total output, income and employment levels are directly related to total private and public spending or aggregate demand.Fiscal policy is normally the responsibility of the minister of Finance.In most countries the minister of finance and the governor of the Central Bank consult regularly. Furthermore there has been an explicit agreement that if any irreconcilable conflict between the two arises, the governor must either follow the written (and publicly released) directive of the minister or resign office.


QFA are defined as operations and actions whose effect can and and should be in principle be carried out by budgetary measures in form of explicit tax,subsidy or direct expenditure .QFA are motivated most of the time by the desire to hide what are essentially budgetary activities for political or other reasons.Examples include subsidised credit facilities and lending to groups of borrowers with inadequate collateral or with unbankable business proposition.By shifting what are essentially taxes and subsidies from government account to central bank account QFA severely distort the measurement of revenue and expenditure they render attempts sto assess fiscal policy meaningless.QFA create contigent implicit liabilities which the government is expected to fullfil there by mortgaging the nations future without proper approval.Since QFA are normally meant to circumvent the normal budgetary process they end up being funded by printing money which leads to hyoer inflation is unchecked.

The use of off-Budget activities for public policy purposes that can be duplicated by specific fiscal measures, such as taxes, subsidies or other direct expenditures leads to policy instability. Public enterprises, for instance, are used to promote or subsidise certain groups through below-market pricing. These quasi-fiscal activities disguise the size of the government, cause over-consumption and waste, and contribute to macroeconomic imbalances.This leads normally to increase in monetary expansion which is unmatched by supply as a result inflation can set in.QFA are not encouraged as they by-pass normal check and balances as offered by the proven systems such as parliament and several parliamentary committees which keep expenditure in line with revenues as provided by budget.

Private spending consists of purchases of goods and services by consumers, by businesses for investment, and net exports (exports minus imports). Governments raise revenues from taxes such as the income tax, sales taxes and payroll taxes, and from other sources to spend on such things as health care, education, pensions, social assistance and defence.This process is guided by the national budget which is crafted by the ministry of finance after consulting with other government departments.This process is critical and if the foundation of public finance.Once the government ascertains its needs it then lookst at ways to fund it needs.The budget spells out all this.The point is to make sure government properly spends within its limits so as to maintain a sustainable budget policy.Any expenditure not provided for in the budget then exposes the nation to the risk of printinng money to cover for unbudgeted for expenses.This is why Quasi-Fiscal Activities are undesirable , as they hide government expenditure and revenues in the same way off-balance sheet transactions hide a Company's true financial position.

Central banks exist in most countries as government-owned institutions operating with considerable independence from the governing political structures. It is crucial, therefore, that the central bank be accountable to the people through their elected officials.For this reason most central banks are accountable to the Minister of Finance . Monetary policy may be sufficiently complex and technical that its implementation is left to experts who specialize in nothing else, but in a well-functioning and market economy, the people must ultimately be left to judge the performance of those experts. Such judgment requires a basic understanding of the main issues.

The monetary policy is aimed at harnessing the benefits of low inflation . Among other things, a credible commitment to keeping inflation low helps create a positive climate for low interest rates and productive long-term investment. This in turn strengthens the growth of the economy and its capacity to generate new jobs. An important benefit of low inflation is that it generates less uncertainty, interferes less with the operation of the price system, and thus imposes fewer costs on society .It is important that fiscal policy and monetary policy be separate even though they are complimentary.A hidden technique of combining the fiscal and monetary policy is generally refered ro as Quasi Fiscal Activity( QFA).It has to be avoided as it seeks to circumvent proven systems such as national budgets which make national institutions accountable to the people through Parliament.

Monetary policy is normally guided by an inflation-control target . This means adopting various measures and steps to keep inflation low and within a certain pre-set level.Low inflation would then bring about stability and translate into a better standard of living for the the nation.Essentially, successful monetary policy requires central banks to invest in the creation, monitoring, and projection of economic information-all devoted to achieving a better understanding of developments and relationships in the domestic and world economies.
Inflation erodes the value of money. When future prices are less predictable, sensible spending and saving plans are harder to make. People increasingly fear that their future purchasing power will decline and erode their standard of living.

Inflation encourages investments that are speculative and take advantage of inflation rather than productive investment. It can also create the illusion of temporary financial success while masking fundamental economic problems. Businesses and households must spend more time, and money, protecting themselves from the effects of rising costs and prices. Businesses, workers, and investors respond to signs of inflation by pushing up prices, wages, and interest rates to protect themselves. This can lead to a "vicious circle" of rising inflation. Inflation can mean particular hardship for those whose incomes don't keep pace with the rising level of prices, especially people on fixed incomes such as senior citizens who are receiving pensions.

Consumers and businesses are better able to make long-range plans because they know that their money is not losing its purchasing power year after year. Interest rates, both in nominal and real terms, are lower, encouraging investment to improve productivity and allowing businesses to prosper without raising prices. Sustained low inflation is self-reinforcing. Businesses and individuals do not react so quickly to short-term price pressures by seeking to raise prices and wages if they are confident that inflation is under long-term control. This contributes to keeping inflation low.

Finally, monetary policy is restricted by the impact of other government actions, especially Fiscal Policy ie, decisions about government expenditures and taxation. Fiscal policy also influences overall economic demand, and if fiscal and monetary policy are not co-ordinated, they can work at cross-purposes.

Central banks choose to focus on maintaining low and relatively stable inflation for two reasons. First, low inflation is beneficial for the operation of the economy. Second, both theory and evidence suggest that monetary policy cannot have a systematic and sustained effect on macroeconomic variables other than the inflation rate. Given this limited scope for monetary policy, it would make little sense for monetary policy to adopt other long-run targets, such as the unemployment rate or the growth rate of real output. It is natural for central banks to adopt a long-run target for the one thing that they can reasonably expect to influence over the long run-the rate of inflation.

When the Central Bank has clearly stated objectives and takes policy actions that affirm those objectives, the result is an increase in its credibility. This credibility, in turn, helps to keep expectations of future inflation close to the inflation target-what is sometimes called an anchoring of inflation expectations Through maintaining low and relatively stable inflation, central banks make their best contribution to the economic health of a nation. This objective is grounded in the propositions that (1) high inflation is damaging to the economy, and (2) monetary policy is unable to have a systematic and lasting effect on macroeconomic variables other than the rate of inflation.

The biggest cost of inflation is the uncertainty that it generates and the inefficiencies it creates by distorting the information conveyed by relative prices. Cross-country evidence suggests that countries with higher rates of inflation also tend to have more volatile rates of inflation.. Stable output growth is desirable. Genuine benefits come from having a more stable growth rate of real output and also from having a more stable output gap.

It is impossible to determine precisely that the greater stability in inflation and output growth has been the result of better monetary policy rather than just a less volatile economic environment. Monetary policy is forward-looking. The transmission mechanism of monetary policy is the complex chain of cause and effect that connects policy actions by the Central Bank to aggregate demand, output, and inflation. Monetary policy works with long and variable lags, and monetary policy must therefore be forward-looking, anticipating events that are likely to happen in the world and domestic economies. For this reason it is important that policy be clearly spelt out and then be given an condicive atmosphere to succeed.
Two types of uncertainty complicate the conduct of monetary policy: uncertainty about the precise workings of the transmission mechanism, and uncertainty about economic events in both the global and local economies. Both types of uncertainty require that the Central Bank invest considerable resources in research, current analysis, and projection in order to make the best-informed policy decisions.This means inflation figures be released on time and be accurate.

Currently there is hot debate whether inflation is 24,000% or 26,000% or 164,000%.This lack of accurate and trusted inflation statistics make the markets unstable.Currently there is a wide shortage of basket goods used to calculate inflation.Households have no choice but to use home-made statisitcs which tend to be closer to reality since they compare actual price movements albeit in the black market.Due to lack of accurate figures business and households generally expect inflation to be very high and in turn ask for higher prices and salaries which feeds the inflation circle.

The RBZ has come up with various programmes providing subsidised funding .These facilities whose rates are as low as 25% include the Agricultural Mechanisation Program (AMP), the Agricultural Sector Productivity Enhancement Facility (ASPEF) and the Basic Commodities Supply-Side Intervention Facility (BACOSSI).This product directly competes with Banks who are supposed to lend to the same clients and earn sufficient interest income to keep the banks afloat. In reality a bank can not match this rate being offered by the RBZ, which has now been converted to a massive commercial bank.These facilities represent a hidden tax since this money is not at market rates.It means someone (tax payer) is subsidising these facilities through an undeclared tax. As noted above these facilities lack an relation to reality.Current money market rates are around 700% -1600%, yet money can be borrowed at around 25% which creates loopholes and leads to market distortions and market inefficiencies.The only reason why this money is so cheap its because its printed money which mistakenly is being viewed as a benefit ignoring the more disasterous impact on money supply and inflation.

As a direct result of QFA the central bank has moved into areas which it doesnt have expertise or capacity.This has dangers especially in terms of giving out loans with no capacity to carry out a proper credit assessment and put in measures to recover the money.Once a lender like the RBZ gets involved borrowers are attracted to such a lender since this lender lacks proper capacity to monitor the loans dished out.The RBZ becomes lender of prefered choice as borrowers stampede for loans which in all likely hood they would never have to repay.Commercial Banks and other financial institutions a better plsced to be providing loans as they have long built check and balances to monitor loans and give other assistance to allow clients to repay the loans in full.

The recent threats to revamp entities such as Zimbabwe Development Company with a view to take over "unpatriotic" companies represents an extension of QFAs.The now much talked about People's shops cant be viewed differently from the controversial Operation Dzikisa Price.If all other Supermarkets cants provide cheap food how can the People's Shops do it without being subsidised?This is how QFA activities mislead the market and distort resource allocation.This trend discourges business to invest .As a result shortages will follow leading to increased black market activities and run away inflation..The formal sector will be further eroded as most economic activity goes under ground to escape unsound policies.

Gilbert Muponda is a Zimbabwe-born entrepreneur, exiled in Canada. He can be contacted at gilbert@gilbertmuponda.com
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