Inflation and interest rates

What is the main economic burden in Malawi today? The unemployed will say unemployment is the problem. But the media usually complain of prices in shops and interest rates in banks. Slow growth rates are seldom mentioned, and yet they have much to do with both inflation and interest rates.

Reducing inflation and interest rates can encourage investors, production of more goods and services will reduce inflation and interest rates. Why the authorities are not reducing them as the solution is as simple as it sounds. We read or hear that in some African countries such as Nigeria, Democratic Republic of Congo, Tanzania inflation is single digit but despite the rhetoric of economic ministers, interest and inflation rates continue to hover well above 20 percent.

Interest rates are the price of capital, the price of obtaining a loan. Where loanable funds are in abundance, interest rates tend to be lower than where loanable funders are less. This explains why developed countries, interest rates seldom go beyond five percent. In some they are even close to zero. Hence the high interest rates in Malawi reflect shortage of credit facilities. But that is half the explanation. The high interest rates also reflect the cartel that is in the banking sector. Tactly the banks offer the borrowers not competitive rates but the live-and-let like rates.

Because inflation rates tend to go upwards rather than downwards, the interest the banks fix is hedging tactics. They put the rates higher than lending to avoid being caught in a sudden surge of inflation.

There is constant foreboarding of hyper-inflation. This is defined as the inflation that increases by 50 percent every month so that by the end of a year prices may have increased by more than a hundred percent. Economic text books usually refer to hyper-inflations that Austria, Germany, Hungary and Poland went through during the 1920s. But next door to us has been the experience of Zimbabwe which has destroyed the once mighty Zimbabwe dollar.

Hyper-inflation is a reflection of the quantity of money circulating in the economy, classically inflation has been defined as too much money chasing too few goods. When there is hyper-inflation the money authorities—the ministry of finance and the central bank—have printed not just too much money in comparison with goods and services available in the economy, but excessively so.

If the money authorities know that excess liquidity (too much money in the economy) can lead to hyper-inflation why do they continue printing extra bank notes. In democratic societies governments are under pressure from interest groups.

Primarily, a government finances its programmes using revenue from taxation. But as elementary economics teaches us the needs are usually greater than the means. The amount realised from taxation is less than what is required to fulfil general election pledges of building roads, bridges, raising civil service pay and perks. The public does not say since you do not have enough to fund all projects and services just provide us with what you can. Instead, pressure groups, say do what you promised. Fearing loss of face and possible loss of the next general election, the government retorts to borrowing from the money market, both from commercial banks by issuing bonds and from the central bank by, in plain language, directing to print more notes. This borrowing contribute to slow down of the economy in that by crowding out private firms from the credit market and by issuing excess notes both inflation and interest rates skyrocket.

There are other contributory factors to the perpetual rise of inflation and interest rates. Workers both in the private and public sectors demand extra pay to stabilise their net earnings in the wake of inflation. Private firms have to two options in the face of pressure. First, with their inadequate budget they raise salaries by declaring some workers redundant in order to raise the salaries of those lucky enough to retain their jobs. Alternatively they may raise prices of their goods inorder to raise money for wage increase without dismissing some of the workers. As a result of wage increases the inflation is compounded by cost push.

It seems to be a vicious cycle for which there is no obvious escape route. But there is a route called “Austerity Highway”.

In the public services increments of salaries should follow, not precede expansions in the gross domestic product (GDP) for several years before increases are made, salaries paid while the economy is stagnant, all you get are nominal (money) increases not improvement in standards of living.

If there are extra goods or services you will just manage to obtain the same quantity of goods at higher prices.

What we need in Malawi is self-discipline.