The purpose of this article is to simplify the complexities of CBN’s monetary policies and how it affects the overall wellbeing of the economy. It is assumed that everyone understands the Central Bank to be the apex bank and lender of last resort, but often confusing is how it controls how much money is circulating and the cost of borrowing.
The monetary policy is the efforts of the apex bank to control the quantity of money in circulation and interest rates. The reason for such actions is to meet specific economic goals, such as reducing inflation to stabilise prices, boosting economic growth, or stabilising the currency. Think of the economy as a farm and the central bank as the farmer.
The farm’s health depends on the right balance of water (money supply) and sunlight (economic policies). If the plants (businesses and consumers) are not growing well, the farmer might decide to water them more (inject more money into the economy) or adjust their position to get more sunlight (implement policies to stimulate growth).
Alternatively, if the plants are growing too fast and risk depleting the soil’s nutrients (an overheating economy leading to inflation), the farmer might water them less (reduce the money supply) or provide some shade (tighten policies) to ensure steady, healthy growth.
This way, the farmer (central bank) uses different tools to maintain the farm’s (economy’s) health. The CBN Monetary Policy Committee (MPC) is a team of experts within the Central Bank established for the purpose of making monetary policies.
This team meets periodically to look at how the economy is doing and then decides what to do about interest rates and other important financial decisions to help achieve the central bank’s goals.
Given the analogy of the farmer and his farm, the Monetary Policy Committee (MPC) can be thought of as the team of expert farmers who gather from time to time to assess the farm’s condition and take decisions to keep the farm healthy and productive.
The CBN Monetary Policy Committee determines the Monetary Policy Rate (MPR). MPR is like the price tag the central bank puts on borrowing money. It’s a special rate that influences how expensive or cheap it is to get a loan.
This rate is used by the central bank to give everyone a hint about how they feel the economy is doing. The Central Bank of Nigeria (CBN) adjusts the MPR to either slow down things when prices rise too quickly (inflation) or to help the economy grow. By increasing the MPR, they make borrowing more expensive, which can help control inflation.
By lowering it, they make borrowing cheaper, encouraging spending and growth. The Monetary Policy Rate (MPR) is like deciding how much to open or close the tap to water the garden. The Central Bank controls this tap to make sure the garden (economy) gets just the right amount of water (money).
If the garden starts growing too wild (inflation is high), they close the tap a bit more to slow things down. If the garden needs more growth (economic boost), they open the tap wider. In the latest CBN monetary policy, the central bank decided to close the tap a bit more, raising the MPR from 24.75% to 26.25% in June, to keep the economy healthy.
An asymmetric corridor is when the central bank sets different interest rates for commercial banks depositing money to the Central Bank versus when they borrow money from the central bank. This creates a window or range within which short-term interest rates fluctuate. Imagine the central bank’s money as a large water tank.
Banks can put water into the tank (make deposits) or take water out (borrow money). The Central Bank uses different rules for putting in versus taking out water to encourage banks to lend more to others instead of just storing their money.
By adjusting the rewards for depositing and the costs for borrowing, the central bank guides how banks handle their money to ensure a balanced economy.