BoG Zero deficit financing can be poisonous
An International Monetary Fund conference on ‘Rethinking Macro Policy’ in April 2015, had participants coming to a general consensus that central banks should retain full independence with respect to traditional monetary policy.
The idea is that, fiscal policy has been associated with the curse of hyperinflation since policymakers usually grapple with feeble growth and financial crisis amid political control.
Ghana is faced with a conundrum where the IMF wants government to accept the request for elimination of a current law which allows BoG to finance deficit up to 10 percent.
But every region has its peculiar situation and it is the reason the Finance Committee of parliament wants the law amended to five percent instead of the zero the IMF wants.
Budget deficit comes about when government tax revenue is insufficient to pay for a given level of state spending and a nation borrows to make up for the difference.
It is normal practice that countries borrow more during the time of serious economic challenges or international economic upheavals like the current tumbling of oil prices, to pay back the debts it owes over a period of time.
Factors that cause budget deficits are deliberate fiscal stimulus by governments to boost aggregate demand. Examples include falling profits due to decreased consumer spending leading to low tax revenue and a deliberate attempt to increase spending on public service and increase in debt service cost due to rise in debt.
The Bank of Ghana being asked to stop financing government deficit may not be a useful medicine. Monetary financing is needed in the developing world to restore growth. Governments often find that they have to borrow to finance their spending.
In developed economies, central banks can adopt independent monetary policy for longer periods without facing consistent fiscal deficits.
In developing economies where structural weaknesses exist, however, political pressure on central banks to monetize deficits is seen as one of the main reasons for a positive relationship between fiscal deficits and inflation. Government’s consciously finance deficits to boost the economy.
This action is considered by most politicians and economist in most countries as a positive step. It is a common phenomenon practiced by many developing countries. Though it raises inflation and it is politically unpopular government’s still see it as the best alternative to run the state.
The IMF’s position that the central bank should stop deficit financing could be because it feels doing so has proven inflationary. It perhaps, also has to do with Ghana needing to fix its long – term problems or risk becoming a failed state, which many would say is impossible.
We don’t need to risk getting the economy to a worse level. Once foreign investors lose faith in our economy, a slack in foreign inflows is likely to trigger a financial meltdown which may be worse than our current situation.
When it happens, the central bank will be faced with precisely the same question, which is printing more money, and thus, weakening the fiscal budget situation and raising the danger of unrestrained inflation.
When inflation is rising and the central bank, which is tasked to bring it down, is under government control, it makes their request to limit how much is spent to finance deficit impossible to be met. And when such government refuses to cooperate it is only saying publicly that it no longer cares about inflation.
The IMF maybe right in trying to seek zero deficit financing for the central bank but there is no need to rush, since parliament is taking a prudent step to bring it down to five percent. What is needed now is the fund’s patience for both parties to find a fair and sustainable path out of our crisis.
The Fund, in a rush to force the zero deficit financing down our throat in the midst of our serious economic challenge, may end up damaging the economy drastically and extend our dire financial period further. We expect the IMF to help us focus on growth as growth would help reduce deficit.
The Bank of Ghana helping to finance fiscal deficits cannot be excluded from consideration. In economic assumptions we all know there can be extreme circumstances in all situations of life which would demand a quick action. Monetary financing of deficits restores growth in many circumstances and also brings down unemployment.
The IMF could have been more charitable by having a clause for unforeseen circumstances. It could state when the BoG could play a role or needs to play a role in financing deficits.
We desperately accepted the Fund’s policy measures but no desperate politician might resort to such a policy after failing to further debate such unwise step in our world.
Certainly, controlled doses of deficit financing could be beneficial; however, strong rules to bar the central bank from monetizing deficits can also be a dangerous poison.