The Bank of Tanzania (BoT) recently made a significant change in its operations. The Bank announced that it would alter how it influences the Tanzanian economy and this modification would take effect immediately, as the Bank intended to begin implementing these changes as soon as possible.
The BoT has obviously wielded significant influence over the Tanzanian economy throughout its history, employing various tools to steer the country’s financial landscape. The BoT primarily influences the economy through monetary policy, controlling the amount of money in circulation. It uses tools like setting reserve requirements for commercial banks, conducting open market operations (buying and selling government securities), and adjusting the discount rate (the rate at which banks borrow from the BoT). By managing the money supply, the BoT aims to achieve macroeconomic stability, controlling inflation, and promoting economic growth.
The issue with managing the quantity of money is that money is not neutral. Whenever the central bank increases or decreases the money supply, it affects the level of prices, through consumer demand.
The Bank of Tanzania is currently in the midst of a significant shift in its monetary policy framework, transitioning from reserve money targeting to an inflation-targeting framework with interest rates as the operating target. This move aligns with the East African Community's (EAC) goal of harmonizing monetary policies across member states.
The BoT’s shift will be from using the quantity of money to relying solely on interest rates as the primary engine for controlling inflation and by extension, economic growth, as opposed to determining the level of inflation merely by the denominations in circulation. In other words, the BoT will attempt to stabilize prices by monitoring interest rates rather than the money supply.
Previously, the BoT focused on controlling the growth of reserve money, i.e., the cash held by commercial banks at the BoT. By influencing reserve money, the BoT indirectly influenced the broader money supply (M3) and aimed to manage inflation. Under the new framework, however, the BoT's primary objective is to maintain price stability, defined as a low and stable annual inflation rate within a specific target range (currently 5%). It achieves this by influencing short-term interest rates, mainly the Central Bank policy rate (CBR).
The shift replaces reserve money with the 7-day interbank cash market interest rate as the key operational target. This means the BoT directly manages short-term interest rates to achieve its inflation target. Emmanuel Tutuba, the Bank’s governor, noted that this move would better regulate prices, benefitting Tanzanians from all works of life. Moreover, the BoT will rely on instruments like open market operations, reverse repurchase agreements, and standing facilities to manage liquidity and steer interest rates towards the target. How would this shift in monetary policy affect businesses, investors, and consumers?
For businesses, this shift will clearly affect borrowing costs, investment and expansion, and financial planning. Since interest rates are expected to become the main tool for managing inflation, and could potentially rise. This could increase borrowing costs for businesses, making it more expensive to invest and expand. Moreover, higher interest rates might initially dampen investment and expansion plans, especially for smaller businesses with limited access to finance. However, stable and predictable inflation could foster a more conducive environment for long-term investment in the future.
For investors, the new framework focuses primarily on domestic inflation, and may not directly address exchange rate volatility. This could be a concern for foreign investors who worry about currency fluctuations impacting their returns.
For consumers, since the primary aim of the new framework is to achieve low and stable inflation, higher interest rates could make saving more attractive for consumers, while also potentially increasing borrowing costs for personal loans and mortgages.
Overall, the impact of the policy shift will depend on various factors like the speed and smoothness of the transition, the effectiveness of policy implementation, and the broader economic environment. But at the end of the day, the main question to ask ourselves is whether controlling inflation through central banking is a sustainable endeavor. The evidence showed that throughout history, inflation has become prominent under central banking. Thus, inflation will remain a problem because the central bank manages the economy.