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Raising Interest Rates Kills Economy, Not Inflation

The conventional view among economists is that higher interest rates lead to lower inflation. To substantiate my argument, observe that since 2022, the Bank of Namibia consistently increased the repo rate in response to rising inflation, but it is not effective.

The endless series of interest rate rises by the Bank of Namibia has stirred up arguments about whether monetary policy is the fairest and most effective way to curb inflation but it is clear that increasing interest rates will not solve the Namibian inflation problem.

The Bank of Namibia raised its benchmark repo rate by 25 bps to 7.25% at its April 2023 meeting earlier this week, effectively bringing the prime lending rate to 11% while the mortgage lending rate reached 12%.

Namibian inflation is currently standing at 7.2%. The rising interest rates could knock the economy into a recession, made cost of living even higher and spiked the unemployment rate. The cost of living crisis will deepen inequality in Namibia and yet no political party is talking seriously about addressing the enormity of this challenge by fixing our broken social safety net. I am talking here about people in genuine distress, who haven’t the money to pay their loan installments. It is unclear how long the cost of living crisis will last. It may be heresy to those who think the Bank of Namibia is all-powerful, but the honest answer is that raising interest rates wouldn’t put out the fire. Short of throwing thousands of people out of work in a depression, higher rates wouldn’t bring supply and demand back into balance, a necessary condition for price stability, simply because the spike in inflation is NOT a result of excess liquidity, but is imported. It is entirely external.

Still, by raising interest rates, the Bank of Namibia hopes to slow the economy by making it more expensive for consumers and businesses to borrow money. The usage of interest rate hikes as a tool to solve the inflation problem could trigger a recession. A rise in interest rates make it more expensive for companies to expand. That, in turn, could lead to cuts in investments, ultimately hurting employment and jobs. Therefore, raising rates would have little impact on the economy because credit growth is already weak.

Additionally, I am not at present convinced that we will inevitably have to lean heavily and constantly increase interest rates to curb of an inflationary psychology. Thus, while we believe that theory should be an important driver of practice, we need to encourage a more thoughtful approach to the way we think about theory. One that promotes thoughtful, critical reflection on the theory itself and the ways that it is being extended and how it is informing practice. We can’t solve problems by using the same kind of thinking we used when we created them.

In addition, with the Fourth Industrial Revolution, the methods we have previously used to solve many of the problems we face are no longer effective. We need to develop new ways of thinking in order to enterprise better solutions, and experiences that solve our current problems. What we need are new ideas that tackle the imported inflation challenges instead of increasing the interest rates.

Moreover, the good news is that a new way of thinking about macroeconomics is emerging and we need to apply new methodologies. Fortunately there are many new economic thinkers now engaged in understanding the complex realities of the world we live in. We need to understand that the Bank of Namibia can only impact the interest rate. It’s unable to do anything about supply chain issues that also cause inflation to rise. When the Bank raises interest rates, it risks hurting the labour market since business revenue may decrease as money costs increase. The rate hikes operate with an interval, and the impact may not be felt in the economy immediately. We should note that some sectors are more sensitive to interest rate hikes than others. The housing market, for instance, is strongly connected to interest rates since increased mortgage rates typically lead to a slowdown as many people are simply priced out of the market, unable to afford higher mortgage payments.

Fixing inflation seems fairly simple in theory, but in practice, there are many concerns like going too far or acting too late with both monetary and fiscal policies. An economic slowdown could lead again to job losses and pain for many people. This is why fixing inflation requires time and patience. It seems like we’re on the right track to fight inflation, but only time will tell how the economy responds with the fear of a recession hanging over us. Higher interest rates don’t only affect long term loans, they also have an almost immediate effect on short term loans. It makes it more difficult for a small business to meet their daily financial obligations in the event that emergency expenses may come up.

Any business owner looking to borrow capital to expand their operations will have to contend with a higher cost of capital to do so. It inevitably also means that operational costs go up. Couple that with the fact that your potential customers now have less discretionary income and you may see your profits go down. When labour wages can’t keep up with the rate of retail prices, inflation, the purchasing power of those wages, decreases. Low income families face it like nobody else; for them any price increase, regardless how small or big has serious consequences.

Workers’ demand for wage increases can lead to a labour costs downturn, resulting in lower profits for businesses. All this can cause a high uncertainty rate in the system, leading to decreased investment from entrepreneurs. Hence, interest rate increases will affect business owners across the country.

To the end, the valid arguments for and against increasing interest rates to control inflation show that this issue is more complex.

Therefore, higher interest rates raise the cost of borrowing money and will slow down the economy with businesses and households feeling the pinch. The use of interest rates as a liquidity tool to solve the inflation problem, has proven itself totally ineffective and instead, could trigger a recession.

Source : NambiaEconomist