The NCX Index on the Zim$ has been computed and confirmed in its first week at 38%. Inversely, this implies a loss of confidence of 62%.
By Colls Ndlovu
Confidence is an intangible asset in economics. By virtue of its intangibility – its intrinsic value is difficult to measure, let alone to manage and quantify. In terms of monetary policy, confidence is gained if the public believes that the monetary authorities will actually carry out their stated objectives like price and currency stability.
Confidence is ipso facto intertwined with trust, that is to say, faith in the soundness of the monetary system. The inflation expectations of the market and, the foreign exchange value of the currency tend to be aligned with the actions of the monetary authorities.
Confidence is the central hub around which currency values revolve. The same applies to price stability. It is driven by confidence and credibility. In central banking, credibility is everything.
Confidence is the new currency. It is what determines the value of a currency alongside trust and soundness of policy. A discredited central bank would struggle to maintain the value of its currency.
An unstable currency destabilises the economy and becomes the Achilles heel of the financial system. The measurability of confidence remains a challenge within the economics and finance professions.
I argue that the measurability of confidence can be used as a powerful metric for both price stability and currency stability.
Such a measure will greatly enhance the existing tools for managing inflation and foreign exchange volatilities. It will help policy makers gain an insight into how their work links with the expectations of the markets.
I table that the Ndlovu Currency Confidence Index (NCX Index) be adopted as a measure of confidence in determining monetary policy. The model is named after its originator and developer – Collet Ndlovu – formerly with the Financial Markets Department of the South African Reserve Bank.
Confidence is intrinsically linked with credibility. By measuring confidence, the credibility of monetary authorities gets enhanced and trust is restored.
Credibility generally means the state of being credible or believable, or having a good reputation. Credibility is believability. In terms of monetary policy, credibility is achieved if the public believes the authority will deliver what they promise.
This raises questions of trust. Markets are skittish by nature. In central banking, credibility is enhanced through low inflation, and currency stability.
Price stability and the stability of the external value of the currency are sine qua non for successful central banking. Credibility is not directly observable. This tends to complicate its measurability.
The level of confidence on monetary policy can be measured by the difference between the official targets for the external value of the currency, the internal value of the currency and the markets’ expectations of these two variables.
The external value of the currency is reflected by the foreign exchange rate while the internal value of the currency is determined by the impact of inflation. The proximity between the official levels and the markets levels is what could be termed the level of credibility.
As the spread widens between the two (targeted and expected) this becomes correlated with the loss of credibility. The NCX Index will be used initially in the Zimbabwean context and then rolled out to the global financial markets starting with key African economies like Kenya, South Africa, Nigeria, inter alia.
Computation of the inflation rate differentials
The calculation of the NCX Index has entailed the computation of the inflation rate differentials as one variable while the foreign exchange rates differentials were used as the other variable.
The weighted average of the summation of these variable differentials equates to a metric which amounts to the loss of confidence.
The inverse of this measured metric is the confidence level. By way of an example, if the loss of confidence metric is measured to be 62%, it follows that the confidence level is 38%.
The NCX Index postulates that as loss of confidence in the currency increases, the level of confidence in the currency decreases. It stands to reason that policy makers should strive to increase the level of confidence towards 100%.
The question which arises is: What then is the level of confidence on the Zim$ as reflected by the very first NCX Index? The answer is that the NCX Index on the Zim$ has been computed using the latest available data and has been confirmed at 38%. Inversely, this implies a loss of confidence of 62%.
Consequently, the authorities must strive to compress the loss of confidence figure towards 0% while increasing the level of confidence in their currency towards 100%. Confidence is about the relationship between the level of expected future inflation, the external value of the currency, and the uncertainty associated with the outcome of these variables.
A good measure of confidence
Confidence, just like trust and reputation is accumulated over time. Confidence is synonymous with reputation and credibility.
In the foreign exchange market, the monetary authorities can target a certain exchange rate level. The markets’ expectation of that value is a good measure of confidence. The markets’ confidence is what gives currencies the values they enjoy.
The value of a currency is correlated with the level of confidence it enjoys from the markets. Confidence is the ability to walk the talk. Inflation targets provide the public with an idea of what authorities’ targeted rate of inflation is.
That can then be juxtaposed with the expectations of the markets of what they think the inflation would be. The closer the proximity to the targeted level, the higher is the confidence level.
Former US Federal Reserve Vice Chairman, Stanley Fischer, remarked that credibility is a slippery concept which should not be overvalued. Credibility can be achieved through the pursuit of policies geared towards price stability and protecting the external value of the currency.
Price stability enhances reputation. Reputation is built through sustained confidence.
A monetary policy that emphasizes the containment of inflation and exchange rates targets therefore enhances credibility through eliminating uncertainty.
Colls Ndlovu, a currency expert, is an award-winning economist and central banker, and is the originator and developer of the NCX Index.
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