adminPreamble:
FISCAL and monetary policies are the traditional instruments or tools used by governments to achieve macro-economic stability through their Finance Ministries and Central Banks respectively.
Fiscal policy refers to the control of government revenue collections and expenditures to influence economic activity-usually enunciated in the form of an Annual National Budget Statement, while monetary policy on the other hand refers to the control of money supply or interest rates by the central bank to achieve the desired macroeconomic objectives. Monetary and fiscal policy are implemented by two different bodies and, therefore, coordination of the policies is required. In Zimbabwe, the fiscal authority is under the Ministry of Finance and Economic Development, while the monetary policy authority is the Reserve Bank of Zimbabwe.
A change in either of these two variables i.e. fiscal or monetary policy will influence the effectiveness of the other, thereby, affecting the overall policy direction of the country. Literature suggests that fiscal policy affects the conduct of monetary policy through several channels, such as interest rates and exchange rates, for example, an expansionary fiscal policy would naturally cause interest rates to go up. Under fiscal dominance, for example, fiscal policy sets the general environment in which the central bank conducts monetary policy. Fiscal policy dominance implies that even when the central bank is viewed as independent, monetary policy can be severely limited by the stance or thrust of the fiscal policy direction that respective countries take.
For example, Zimbabwe has run an expansionary fiscal policy from independence in 1980, which has resulted in budget deficits to date. There are two possibilities which the Government may resort to, in order to finance the fiscal deficits. First, the Government can finance the deficit through money printing (seigniorage) or borrowing from the domestic market. In many situations, the Government may resolve to finance the deficit through the printing of money which implies monetary policy expansion. Expansion in monetary policy results in inflationary pressures in an economy which may lead to a devaluation of a nation’s currency, balance of payments challenges as well as a banking crisis such as the hyperinflation era of 2008 for example.
The Government may also resort to financing the budget deficit through borrowing from the domestic banking market, thus affecting the monetary policy’s credit transmission channel. High budget deficits are often associated with the crowding out of the private sector in the money market, as fiscal authorities finance budget deficits by borrowing from the domestic banking sector. This results in an increase in lending rates as demand for credit outstrips supply as the Government competes with the private sector for limited available credit. As the cost of credit increases, so does the cost of production and the general price levels.
Why coordination of the two policies then becomes important?
The importance of effective and efficient coordination of fiscal and monetary policies as a catalyst and vehicle for sustainable economic growth needs not to be over emphasised. The coordination of these two macro-economic policies, when efficiently done would bring about or help in achieving both internal and external equilibrium, that’s according to economics literature.
The two policies function or operate in different time frames for example. Monetary policy is usually frequently adjusted through monetary policy quarterly or bi-annually reviews in some countries, while fiscal policy tends to be fixed throughout the fiscal year that it relates to, unless there has been a need for a supplementary budget for example. Literature suggests that inefficient coordination of the two policies would give rise to sub-optimal economic outcomes that will impinge negatively on the general economic growth of the country.
The effective and efficient coordination of the two policies can only be achieved if each policy is on a sustainable trajectory or path. Otherwise unsustainability in one policy will have negative trickling effects or spillover effects on the other, rendering the entire macro-economic position unsustainable i.e. disequilibrium and macro-economic destabilisation of insurmountable proportions. In other words, financial instability and weak fiscal policies can have a negative impact on each other. That’s, sound fiscal and monetary policies are critical for sustainable economic growth, i.e. the two policies should always operate in harmony with each other and not in discord. For example, financial or monetary quantitative easing and highly expansive fiscus characterised by increased government spending and reduced taxes were employed by the monetary authorities of the European Union at the height of the global financial crisis. Hence efficient coordination of monetary and fiscal policy became a necessity to ensure a sustainable policy mix in the aftermath of the global financial crisis to avoid the two policies to operate at cross purposes.
Challenges posed by multi-currency regime in Zimbabwe, and rendering ineffective management of fiscal and monetary policies
Like I have always said, when Zimbabwe adopted the multicurrency regime in 2009 our monetary policy authorities, RBZ, lost monetary policy sovereignty or monetary policy autonomy. This implies that the RBZ became unable to employ traditional monetary policy instruments, such as exchange rate as an adjustment mechanism to fine tune the economy. The RBZ ceased to print money and thus benefit from seigniorage-opportunity cost. Seigniorage is the difference between the value of money and the cost to produce it—in other words, it is the economic cost of producing a currency within a given economy or country. The RBZ ceased to be the lender of last resort as well. In this regard, the role of monetary policy has become limited and impaired-i.e. it has become a lame duck. As a result, the interaction between monetary and fiscal policies in our country has taken a different dimension all together, with fiscal policy now dominating under the multi-currency regime, what it means is that Zimbabwe must ensure that there is always fiscal sustainability. Unfortunately, fiscal stability has eluded Zimbabwe since prior the hyperinflation era.
This is evidenced by huge fiscal deficits that ran on an average of nine percent of the country’s GDP from 1980 to 2008. The deficit lowered to an average of about three percent of the GDP after Zimbabwe adopted the multi-currency regime that resulted into economic rebound of an average of about 11 percent GDP over the period 2009 to 2012. Unfortunately, this rebound became short lived, from 2013 as the country could not sustain a cash budget trajectory. Revenues started declining, as more and more companies shut down. The Government was left with no choice but to resort to domestic borrowing further crowding out the productive private sector as lending market rates sky rocketed. In the absence of a domestic or sovereign currency, the impact of fiscal policy on smoothening of the monetary policy is expected to be minimal. Naturally fiscal policy can affect monetary policy through its impact on interest rates and financial stability.
As alluded above the adoption of the multi-currency regime in 2009 subordinated the role of monetary policy to fiscal policy as the fiscal policy dominates. Under the multi-currency regime the Government could no longer borrow from the central bank. This effectively means that the Government had to finance its deficits by borrowing from other financial institutions other than the RBZ and from non-bank domestic sectors. As the fiscal space continued to narrow, the government resorted to issuance of Treasury Bills to finance the budget deficits. The issuance of Treasury Bills naturally impacts on monetary policy fundamentals such as interest rates. This calls upon a closer coordination of fiscal and monetary policies to ensure that fiscal deficits are financed on a sustainable basis.
In conclusion, Zimbabwe is operating under limited and impaired capacity to influence policy through monetary policy following the adoption of the multi-currency regime from 2009. The effects of fiscal policy shocks on money supply and interest rates is being insignificant since adoption of the multi-currency regime from 2009. Specifically, the impact of fiscal policy on money supply has been largely insignificant. Fiscal policy becomes instrumental in influencing economic activity under the multiple currency regime environment. The need for coordination between monetary and fiscal policy remains highly critical in a multi-currency regime environment. Given the dominance of fiscal policy under the multicurrency regime, it is critical and imperative that the government effectively implements its fiscal policy to impact positively on the economy – a missing link in the proposed 2017 National Budget recently announced.
Dr Bongani Ngwenya is a Bulawayo-based economist and senior lecturer at Solusi University`s Post Graduate School of Business
Bongani Ndlovu