Welcome to Applied Macroeconomic Centre

A theory is appropriate as long as it fits into the fact; when a theory doesn't fit in the fact, it's wise to walk with the fact.

Thursday, March 29, 2012

Debate on interest rate continues...

Professor M.A. Taslim writes in favor of a competitive interest rate regime in the banking sector of Bangladesh and criticizes BB's policy in this regards. He supports a view that letting interest rate to rise under a competitive market regime will bring the objective of the central bank's money supply squeezing.

Here is the link of his opinion.

Comment: If we compare the interest rates now and a few months back, the answer is – ‘yes, the interest rate is currently higher than what it was previously.’

Is our banking sector is competitive enough to enjoy a competitive interest rate regime? The straight answer is ‘NO’. If a competitive market sets a high price for consumer, then why not the authority will interfere in the market? It’s just like another market. As we know all know, higher prices (in this case, it is higher interest rates) are detrimental for consumers, then it is kind of duty of the authority (in this case, it is the central bank) to control that price, exactly what has been doing by Bangladesh Bank.

What we will achieve through letting the interest to rise (or, a competitive one)? Money supply will reduce so that inflation will reduce also. What percentage of inflation rise is determined by money supply rise? Do we know this? But we know clearly that local investors take 33% of their working capital and 30% of their capital for new investments from financial institutions; in the case of foreign investors, these ratios are 43% and 31%, respectively (Please see the report of the World Bank and Bangladesh Enterprise Institute (2003): ‘Improving the Investment Climate in Bangladesh: An Investment Climate Assessment based on Enterprise Survey’). What does it mean when interest rate rises? These will raise the cost of funds, which will eventually increase the general inflation.

What about our goal for inclusive growth? Shrinking money supply through letting interest rate rise will achieve this goal? No way. Investment will decline, so output will be less, growth will decline and if output declines, it will also affect the price level negatively.

So, suggesting interest rate to rise to control inflation (or, whatever) will basically raise the price level if we consider the supply side effect of interest rate rise is more dominant that its demand side effect, which basically the case is. The Bangladesh economy is not a developed one, rather a developing economy. Market based theories rarely work here.    

No comments:

Post a Comment