Across the world, prices of goods and services have risen as economies are slowly emerging from the restrictions that governments and medical authorities felt necessary to emplace in containing the spread and death tolls from SARS-CoV-2, the virus that causes COVID-19. Unsurprisingly, shops, offices, and businesses have come out of these lockdowns much slower than their patrons have opened up their wallets. The resulting excess of demand over supply has been the main driver of rising prices everywhere.
For a while, monetary authorities, especially in Europe and North America, were convinced that this shock to the supply-demand balance was transitory, and so held off responding to it. That was until evidence began to emerge of tightening labour markets, and of price rises in the sectors of the economy where price behaviour was traditionally non-volatile.
Accordingly, last month saw the U.S. Federal Reserve System commence the tightening of monetary conditions through the raising of interest rates. The Bank of England had commenced the tightening much earlier, while the European Central Bank, by hastening the winding down of its bond-buying programme, has prepared the way for a hike in its benchmark rate. Significantly, central banks in frontier/emerging markets had started putting up their benchmark rates earlier and faster.
PREMIUM TIMES understands that by redirecting money from circulation back to bank vaults, higher interest rates help to choke off the demand pressures that drive inflation. This is the logic of the less accommodative monetary policies that we are beginning to see in developed economies. Higher rates in those economies also mean that investment funds will move monies out of dodgier jurisdictions back into these safer financial havens. Accordingly, frontier and emerging market economies acted to increase the attractiveness of holding assets in their currencies by increasing the returns thereto.
Over the last two years, inflation in Nigeria has averaged 15 per cent – rising, for instance from 11.02 per cent in August 2019 to 18.17 per cent in March 2021. It closed in February at 15.70 per cent. In responding to this pressure, the Central Bank of Nigeria has argued that the main drivers of the price pressure were transitory, and so did not require any action on its part.
Along with most Nigerians, PREMIUM TIMES has waited for this transition to end and the rate at which domestic prices rise, to start falling. The only process that appears to be at an end, though, is the average Nigerian’s capacity to spend. By holding off from reining in rampant inflation, the CBN has contributed to a rapid erosion of the average Nigerian’s purchasing power. And the longer it holds off from acting to restrain inflationary pressures, the more harmful would be the side effects of the needed medication.
PREMIUM TIMES understands that a major trade-off is involved when interest rates rise. Whereas inflation may be successfully throttled, as Paul Volcker did in the U.S. by raising interest rates in the 1970s and early 1980s, it often pushes an economy into recession. Indeed, the markets are already interpreting the recent inversion of the yield curve in the U.S. as heralding a recession.
The Central Bank of Nigeria may thus be right when it argues that on this interest rate conversation, it has opted for economic growth over holding inflation down. Unfortunately, this newspaper struggles to accept this argument in the face of the available evidence. Banks are the key transmission mechanisms through which the CBN’s interest rate policy affects the economy. When the central bank puts up its benchmark interest rate, the returns to retail deposits go up, pulling money out of the economy back into bank vaults. But the cost of loanable funds goes up too, constraining economic activity.
However, over the period in which the Central Bank of Nigeria has pursued its zero-bound interest rate policy, the only rates that have gone down are the ones that depositors get from their banks. The consequent push of deposits out of bank vaults into circulation may have fuelled the pivot by cash-rich segments of the economy into other asset classes, putting pressure on the naira along the way. Banks, however, continue to charge upwards of 20 per cent for retail lending and circa 14 per cent for their big business customers. In other words, the difference in interest income that our banks obtain from loans and mortgages over the interest expense that they pay to holders of savings accounts, may have risen from an average of about 5 per cent to an average of 15 per cent in the last two years.
Were the CBN to raise its benchmark rate, therefore, PREMIUM TIMES cannot see this feeding into already elevated bank lending rates. It would, however, reward depositors who refrain from spending and so help contain domestic price rises and the pressure on the naira.
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