Is Kenya having the Stevie Smith’s Not Waving but Drowning moment?
That is the question many people are asking after weeks of bitter public exchange over the state of the economy.
When Ms Smith published the so-titled popular poem in 1957, the intention was to narrate how a man’s distressed thrashing in a pool was mistaken for waving, leading to his drowning.
So when the pendulum swings from the Kenyan economy “is doing just fine” to “it is heading to hell in a hand basket” and back, it will take a careful examination of policy options and the choices that have been made to know whether it is indeed a waving or a drowning.
Let’s start with fiscal policy, which has received considerable focus but which, unfortunately, has not been subjected to rigorous examination beyond the arithmetic of the level of the fiscal deficit, the nominal debt amount, and accountability.
The phrase “fiscal discipline” is now common place, even when those invoking it are simply referring to the dogged bean counting. Admittedly, the bigger policy debate is to argue a case for “fiscal rules” that anchor the much-talked about discipline.
In economics discourse, a rule-based policy is often associated with monetary policy where the central bank is given a target — for instance the inflation target in the case of the Central Bank of Kenya (CBK) or inflation and unemployment in the case of the US’s Federal Reserve Board.
While the central bank has quite a bit of discretion, its discipline is towards attaining the given target(s). In many jurisdictions, central banks have adopted variants of a near-rule — call it a rule of thumb — that economists refer to as the “Taylor rule”, named after John Taylor, an American economist.
According to this “rule”, a central bank adjusts its policy rate — an equivalent of the CBK’s Central Bank Rate (CBR) — based on the gap between actual inflation and its target and actual output growth and the potential output growth.
So why don’t we then have a neat fiscal policy equivalent of the Taylor rule? Because, I could argue, fiscal policy is as much a function of politics as it is of economics.
If I am right, then it makes sense to add that one is more likely than not to see non-benevolent behaviour amongst the political class when it comes to fiscal policy — in pursuit of its narrow interests that lead to the so-called deficit bias.
If benevolence means the incentive of government is to maximise citizenry welfare, then two conditions need to prevail. One, public debt needs to rise gently, with any upward blips being responses to shocks.
Two, both tax rates and government recurrent expenditure need to be fairly stable. Any major deviation from these two conditions results in deficit bias.
A search for the reasons for deficit bias has led scholarly work towards at least three broad areas.
The first is where optimism is a consequence of taking leave of realism. It begins with a very ambitious output growth outlook that is the basis for policy makers’ optimism about future tax receipts.
Ensuing from the rosy tax revenue expectations is projected hefty expenditure.
In the Kenyan case, if the output growth projections are missed as some of us have argued they would, then the whole scenario cascades into the fiscal deficit from the 201516 fiscal year ballooning beyond the forecast equivalent of 8.2 per cent of GDP.
The second is where there is impatience either on the part of the policy makers or the public, or even both. Economists call this hyperbolic preferences — where people prefer a smaller reward than a larger delayed reward.
May be a bird in hand is worth two in the bush. But such attitude comes with a tendency to exploit future generations.
A surge in public debt such as what we have seen in Kenya in the recent past is essentially a transfer of resources from future to current generations and could point to negated altruism towards future generations.
Thirdly, even if we were to assume that the policy makers and the public are not unduly impatient, expectations of future political prospects would play a role in engendering deficit bias.
In other words, if such prospects are perceived to be dwindling then some could interpret a rise in debt as a deliberate endeavour to constrain what future governments can do.
This takes us to where the relationship between monetary policy by the CBK that has instrument independence but not goal independence — it can set the CBR and deploy other instruments to meet a goal set by the Treasury — and fiscal policy.
Evidently the two policies are pulling in different directions, for the expansionary fiscal policy that embodies the deficit bias is accompanied by a monetary policy that has a tightening bias meant to anchor macroeconomic stability.
What gives? Whenever the effort to assure macroeconomic stability collide with an increasing fiscal deficit, fiscal policy often prevails, thus economists coining it fiscal dominance.
As I learnt from a 2008 study by Federal Reserve economists Michael Kumhof, Ricardo Nunes, and Irina Yakadina titled ‘Simple Monetary Rules under Fiscal Dominance’, fiscal dominance leads to a covert reversal of the traditional roles of monetary and fiscal policies.
In other words, the central bank’s role to deploy instruments towards macro stability will be encumbered by the need to pursue a policy that guarantees stability and solvency of public debts and deficits, whereas fiscal policy remains expansionary when it should be reoriented towards an alignment to assure stability.
Under such circumstances, there are temptations galore. High on the list is the inclination to question whether the five per cent medium-term inflation target serves the broader public policy aspirations.
Those so tempted may ask how was the target determined anyway? They may go further and ponder: will it make any difference if the inflation target was 10 per cent?
In any case it is emerging that prominent economists are now for instance questioning the Federal Reserves’ two per cent inflation target, arguing that it is too low.
Like all temptations, tweaking the inflation target simply for expediency is a recipe for potential fiscal profligacy if the basis is the dilemma that fiscal dominance poses.
My view is that we should start having an engagement on the need to have fiscal rules as a way of guaranteeing fiscal and debt sustainability.
As informed by numerous studies, such rules should entail explicitly targeting the level of the primary deficit — one that excludes debt payment — which then links to an implicit debt target.
Such rules could of necessity be accompanied by a fiscal agency — some call it a fiscal council — independent of the Treasury (or if it is part of the Treasury, having independent status such as those of the CBK’s monetary policy committee) to ensure not only compliance but also the plausibility of budget assumptions.
Unfortunately, this is not an engagement that we are having now. All we have at the moment is a public litigation of whether the economy is waving or drowning, or a near-unanimous call for austerity, as if it is a substitute for more compelling fiscal reforms that a rule-based regime could force.
Osoro is the director of Kenya Bankers Association Centre for Research on Financial Markets and Policy
SOURCE: BUSINESS DAILY