Recently, Nepal Rastra Bank (the central bank of Nepal) published monetary policy for the fiscal year 2075/76 B.S (FY 2018/19). The policy is framed to achieve the targeted economic growth of 8% and incorporates important features including—decrease in cash reserve ratio, statutory liquidity fund and interest rate corridor. Similarly, the policy rate of central bank has been fixed to 5% and importantly, the central bank has targeted inflation to limit within 6.5%. The blog attempts to briefly highlight the role of monetary policy focusing on the variables—inflation and labor market and argue why the latter practice might be best for Nepal instead of focusing on inflation only. The blog is based on the findings of Faia (2008) and my ongoing PhD research on monetary policy.
Since early 2000, monetary policy makers are attempting to promulgate optimum policy which could be applicable under different conditions. One school of monetary economists argue that monetary policies should solely focus on inflation. This view is popular among the policy makers across the world. They argue that by targeting inflation, economy experiences less inflationary fluctuation at the lower cost of output. Theoretically speaking, assumption is right considering the existence of Walrasian labor market (where labor demand equals labor supply so that whole economy is in general equilibrium condition). In this regard, NRB-just as other central banks- is also following the given assumption while formulating the monetary policy. As a result, that they have targeted inflation to limit within 6.5% for the next fiscal year.
Nevertheless, there are several shortcomings of such monetary policy and assumption becomes more problematic in case of countries like Nepal with high unemployment. Besides high unemployment, abundance of labor as a factor of income in comparison to capital is another undesirable characteristic of Nepali economy. In other words, Nepal is a labor intensive country but with high unemployment. Considering these two facts of the Nepali economy, policy makers should have also focused on labor market while drafting monetary policy.
Inclusion of labor market condition while formulating monetary policies includes following benefits:
- Focusing on labor market in addition to inflation helps the labor intensive economy to promote employment
- Focusing on labor market helps the government to focus on labor rights eventually strengthening the labor That is because the outcome of the monetary policy targeting inflation and labor market depends on the bargaining power of workers and hiring companies and only strong labor market institutions ensure the balance between bargaining powers of hiring and labor sectors.
- Monetary policies focusing on labor market and inflation together will start the discussion about wage of workers as monetary policy transmits through marginal cost of the production sector which is dependent on wage and labor
It can be concluded that because of the high unemployment rate and abundance of labor as factor of production relative to capital, it might be optimum for Nepali policymakers to focus on inflation together with unemployment in order to achieve the best result.