The Case Against High Interest Rates in Time of Contagion - Bola Tinubu

Sunday, May03, 2020 10:23 PM / by Asiwaju Bola Ahmed Tinubu/ Header ImageCredit: PulseNG

Economic Policy

The economic fallout from the coronavirus may presentthe best, most pressing case for revising the CBN's high interest rate policy.The undue rates penalise domestic investment and consumer borrowing.

This reduces both aggregate domestic supply and, to alesser degree, aggregate domestic demand. The chronic gap between domesticsupply and demand has been filled by bloated levels of imports & encouragedan overvalued exchange rate that the high interests have helped produce.

In normal times, the high interest rates also attractsignificant foreign financial speculation, the ever-ominous hot money. While inthe short-term, the foreign speculation boosts financial inflows.

Over time, as compound interest payments become due onthese foreign investments, the nation will lose an ever-increasing amount ofmoney to satisfy foreign debt obligations. In the short run, high rates seem toattract foreign capital and spur the economy while giving it discipline againstinflation. In the longer-term, all of this is untrue. High rates give us theworst of both worlds.

They stifle domestic investment and incomes whilepushing up inflation and exposing an ever-increasing share of our financialsystem to foreign manipulation and dependence.

Put another way, if you take a single picture early inthe process, the high interest rate policy looks good at that moment in time.However, if you view the entire movie, you will see an ending that is bothpainful and unnecessary.

The Central Bank of Nigeria has demonstrated itsfinancial agility by establishing a growing number of special financingprograms for various industries and sectors of the economy. While theseprograms look good at first glance, they also expose important contradictions.

The special schemes are an implicit admission thatnormal rates stifle investment borrowing and thus suppress the economy. Theextraordinary schemes would not be required if the general interest rate was ata proper level.

By establishing the special programs, the CBN attemptsthe impossible. On one hand it defends the general rate as prudent. On theother, it proliferates special exceptions in order to spur investment borrowingthat the general rate has heretofore stifled.

This complex CBN rear-guard action does not serve thegreater purpose. It merely prolongs the inevitable: We must retreat from highinterest rates if we want investment borrowing to attain levels that actuallyincrease private-sector growth and job creation.

The modern global economy is built on credit.Prosperous nations have built success based on the sustained ability to usecredit to generate high levels of domestic investment as well as allow forsignificant consumer financing.

The Story Thus Far

The current form of our financial system isantithetical to growth. Broad and diffused growth was not the goal. Such growthcontravened the underlying tenet of military rule - tight, centralised controlof political power and economic resources.

There were no nodes of power truly independent fromthe centre. Nor did this situation foster creative and innovative economicthinking leading to sufficient business start-ups that might have grown anddiversified the economy.

Thus, the banking system became one intended to barmost businesses and people from access to sufficient commercial and consumercredit, a system constructed to suppress large-scale independent economicactivity unless expressly sanctioned and approved by arbitrary power.

As such, we are in a situation where the bankingsystem is not sufficiently governed by the rational dynamics of economicmaximization. Without optimal financial sector support, the productive economyhas failed to grow as it should.

A Dangerous Old Fallacy

Defenders of the high interest rate policy claim highinterest rates quell inflation and maintain sound exchange rates. Many localeconomists who remain wedded to a brand of conservative monetarism support thisposition.

Bola Ahmed Tinubu

However, that school of thought has been discreditedby the failures of Thatcherite policies of the UK in the 1980s, by monetarypolicies implemented to cure the 2008 financial crisis and by the financialpolicy moves being undertaken today to fight the coronavirus.

Long Term PositiveRelationship Between High Rates And Inflation

Over time, high rates cause more inflation than theyprevent. In the initial phase, high rates might lower inflation. Feedback loopscreated by the initial high rates will eventually encourage inflation.

Exchange Rate And TheEconomy

If we went to a freely floating exchange rate, thenaira would devalue. This means our currency is overvalued in terms of ourtrade with the outside world.

This overvalued exchange rate is buoyed by highinterest rates.

Coronavirus And TheOpportunity To Lower Interest Rates

Another consideration we must weigh regarding interestrates is how lowering rates along with other innovations may unlock thepotential for real estate to be catalyst for economic growth at this moment.

Conclusion

High interest rates are a fundamental drag on nationaleconomic growth. Only our unreliable power supply may loom as a biggerimpediment to national prosperity.

Lower rates will spur domestic investment andproduction. This creates both jobs and wealth. High rates serve only tosuppress these vital factors. Lower rates will have some negative short-termimpact on inflation and the exchange rate.

However, in a twist of irony, the economicdislocations caused by the coronavirus serve to mitigate those temporarynegative consequences. If there is a time to reduce interest rates, that timeis now.