The US central bank, Federal Reserve, has two main jobs: optimize the strength of the US dollar by managing inflation, and boost employment via interest rate management. So, the apex bank does optimization to balance jobs and inflation. In a credit-based economy, the US has many tools since when an interest rate is increased, you can put a pedal on consumer demand even as saving increases. The end goal is that you can “slow” the economy!
But when it comes to Nigeria with negligible consumer credit (we’re a cash based economy), things change. This is not an online post with no empirical insight; I studied banking and finance to a doctorate level (thank you Diamond Bank). In my research, I focused on currency and global trade, this is what happens when you focus on increasing interest rate in Nigeria:
– As a non-credit consumer based economy, when you increase interest rate, most times, consumer demand is not affected since only a negligible few buy things on credit (yes, loan) in Nigeria. This is different in the US where they have a large consumer credit base!
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– Even as consumer demand stays largely unaffected, increased interest rates make the cost of capital higher for companies. As that happens, they will not expand production since funds are expensive. Result? Lesser Supply of goods in the economy, ceteris paribus. That triggers more inflation!
– Also, if your rates are very high, companies and people will just go and save since the returns are better. Most savers are getting an average of 21% in Nigeria. If you can get 21% per year by keeping your money in a bank, why do you need to worry about building factories and disturbing yourself? Impact? Supply is reduced, triggering more inflation.
Good People, Nigerian policymakers need to be real. You cannot keep rates this high without a special window to make sure manufacturers and producers can get cheap capital since this inflation is mainly coming due to inadequate
We need to break this vicious circle, and that can only come via SUPPLY side since Nigeria does not have tools to influence demand. Forget what they’re doing in the US, UK, etc. Those places have strong consumer credit system.
I have an idea – institute Purchase Agreement with manufacturers- where you ignite Supply, via secondary interest rate window, while removing interest rate arbitration in the banking sector.
Comment on Feed
Comment 1: Yet the % of cash outside the banking system keeps increasing. It was 1.4 trillion as at March 2023 (88%) and now 3.83 trillion (93.34%). Ndubuisi Ekekwe how do you tame this? I guess the funds being targeted by increasing interest rate are not with the common man.
My Response: “Yet the % of cash outside the banking system keeps increasing. ” – you made my point. You think people who live hand to mouth will respond to your HIGH interest rates to save, by bringing the funds from the pillows to banks. Simply, the bulk of the funds (in consumers’ hands) are not affected by the monetary policy. But what is affected is the funds (with producers) needed to improve Supply since those are in the banking system. Impact: lower supply even as demand remains unaffected.
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Nigeria’s fiscal and monetary policies are not designed to solve Nigeria’s problems, it is not about what they say but what they do. What the CBN does makes portfolio investors feel better, at the expense of your manufacturers. That has always been the idea. If the move is not counterproductive, then it’s not Nigeria.
Here, we fight inflation by introducing more inflation, and it goes on and on. If you think excess money supply is the problem, the next question becomes – in whose hands is the excess money? Your policymakers don’t know, instead they tighten and tighten, until the rope cuts.
When you increase rates in a largely poor population with little production capacity, what are you aiming for? Practical reason is always far from us, so we keep doing what we heard or saw others doing, without ever checking whether the constants and variables are the same. When you don’t own your thoughts and actions, you are there for the taken.