November 01, 2024
Economy

Increasing interest rates not a solution for inflation, may harm economy

April 19, 2023
Increasing interest rates not a solution for inflation, may harm economy

The 25 basis points increase in the Repo rates from 7.0% to 7.25% announced on the 19th of April 2023 by the Bank of Namibia will not address the root causes behind the current inflationary pressure and if anything at all, it will only harm the economy.

Interest rates are a crude tool that poorly meet the challenge of today’s inflation. especially for a country that is in a fixed exchange rate regime (CMA) like Namibia. A fixed exchange rate is an exchange rate where the currency of one country is linked to the currency of another country so they can trade freely and smoothly with each other.

With this arrangement – nothing can stop highly priced South African goods to come into Namibia and create inflationary pressures. The main issue with fixed exchange rates is that it limits a central bank’s ability to adjust interest rates to affect a country’s growth rate and other macroeconomic aggregates such as inflation rate.

The true cause of inflation in Namibia

The Bank of Namibia believes that inflation is caused by too much money floating around in the economy and think that the only way to lower it is to keep the amount of money in the economy relatively constant – since the beginning of this interest rate tightening episode, inflation rate has been on a serious increase! This approach called monetarism remains largely unsuccessful in combatting inflation.

Truth is that more money in the economy isn’t a problem as long as supply can keep up with demand of goods and services, besides, it is clear as daylight that the current inflation in Namibia is being driven by supply shortages, not too much money. 

Here is how! Inflation happens when demand for goods surpasses the supply of goods. This has been and is currently caused by structural factors that has constrained and reduced our economy’s ability to supply goods.

We have recently witnessed the manifestation of this during the COVID 19 pandemic, when lockdowns caused shortages throughout global supply chains – prices sharply increased. We have also seen it happening when the Russian invasion of Ukraine affected the availability and price of grain, fertilizers, and fossil fuels. When this happens, the price people are willing to pay for available limited goods increases dramatically.

Thus, the shortage of goods and the inflationary pressures this has created cannot be solved by quickly draining money out of people’s pockets raising (Repo) interest rate. Namibia’s productive capacity is very small and manufacturing base is almost non-existence - setting up new factories is expensive and requires highly skilled workers something that could take months or years to complete. 

Even though it is obvious even for the Bank of Namibia that the current inflation is being caused by supply issues the central banks is still adamant that draining money out of people’s pockets is the one and only way to address inflation.

This approach is detrimental to the economy, because it reduces money circulation in the economy and stimulate economic activities - with this comes less investment in the economy and massive unemployment. This eventually hurts the economy and causes severe economic hardships for households. Instead of trying to solve a supply crisis with demand management, the Bank should fundamentally assist Government to reorganise the economy to address the supply constraints. 

Alternative policy options

The current economic consensus that assumes that only Bank of Namibia (with its submissive monetary policy) can address inflation and that governments should stay out of their way is flawed. It is because of this understanding that our government has been perhaps too silent on the damage high interest rates are causing to the economy and hesitant to spend more money to cushion less privileged households from economic hardships caused by high interest rates.

Nonetheless, there is a great deal that fiscal policy - instead of a submissive monetary policy can accomplish in the face of raising inflation.

Firstly, it is important to understand the causes behind inflation (and also to remember that Bank of Namibia is not an inflation-targeting bank like South Africa Reserve Bank (SARB)), and try to understand what can and cannot be fixed. For example, governments should be helping to repair supply chains and transportation networks in the short term, and thinking about how to make our country’s industrial policy resilient to future challenges in the long term. This can be fixed!

Secondly, in times of inflation such as these, our government should think of other ways how to provide public alternatives for high priced items. For example, if petrol and diesel prices are going to be high in the long term, government should think about how to make it easier and cheaper to get around without needing these pricy fuel linked form of transportation. This is a more targeted and equitable way of reducing demand for a high priced good without subjecting households to high interest rates the central bank religiously believes in.

Thirdly, Governments can also regulate prices of administered goods and services without creating any material market distortions. Rent control is a good example of this. Wherever possible, policy makers should think about how to maintain the supply of goods that are price controlled.

Fourthly, government can also play a big role in making life more affordable for everyone especially the less privileged members of our society by using already existing social safety/protection programmes.

Government spending on everything from childcare and healthcare to public transportation and recreation can be (tailor-made) to make life more affordable for people, and makes everybody less vulnerable to periods of inflation and the subsequent high interest rates of the Bank of Namibia.

*Mally Likukela is the Managing Director of Twilight Capital Consulting

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Last modified on Thursday, 20 April 2023 14:33
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