By Hema Senanayake –
There is a significant difference between scientists and economists. Both scientists and economists use certain methodologies when testing hypotheses in their respective fields of study. However, the end results differ vastly; in science dogmas cannot prevail but on the contrary dogmas prevail in the domain of “economic science.” Yet, this does not mean that we can ignore the importance economic science, instead it shows the necessity to remove dogmas from economic science which science that paves the way to thrive human civilization in each country and globally. I wrote this to point out that dogmas exist in using interest rates by the Central Banks as policy tools to steer the monetary policy in any given country and Sri Lanka is no different.
Recently, the Central Bank of Sri Lanka (CBSL) increased its two main policy rates and as a result the market rates of interest will go up sooner. On this decision economists are divided – And some economist hailed the decision while some others opposed it. It is on record that I did not support the increase of rates of interest; instead I support the idea of keeping market interest rates steady in mid-single-digits within normal periods of economic growth if the government does not intend to deflate systemic bad debt by a policy known as wage-increase-bound-moderate inflation. For an example, a study done in the U.S. has shown that if the minimum wage in the U.S. is increased by 75%, there would be a mild inflation of 2 to 3%. The impact of such a policy would be that it revive the badly weaken credit cycle by deflating the existing debt in general. This theory is not in the main stream yet but at least one U.S. billionaire has supported the idea from a different perspective by writing an article under the caption, “The Capitalist’s Case for a $15 Minimum Wage” from which article he demands to double the minimum wage.
However, when come to Sri Lanka, all economists agree that inflation must be contained and the widening deficit in the nation’s current account must be kept constantly under check within a desirable range so that there won’t be any negative pressure on the Balance of Payment. If there is a severe negative pressure on the Balance of Payment emanated from an increasing deficit of the current account now, even if there was no foreign debt obligation originated from Rajapakse regime, the country has to take foreign loans, if non-credit based inflow of dollars such as Foreign Direct Investments (FDIs) or foreign grants cannot be increased significantly.
According to the press release, the CBSL has increased rates in order to contain inflation and widening trade deficit and to support the Balance of Payment situation. Some economists and some analysts are jubilant over this decision but I am not because I do not believe that rates hike would not support to achieve the very goals mentioned in the CBSL’s press release. Therefore, I suggested using combination of novel policy and administrative tools through which the intended goals could be achieved while keeping the interest rates low and steady. The reason for my insistence is arising from a clear understanding that the present money-based system of economy has a severe contradiction and that contradiction cannot be simply mitigated by adjusting rate of interests and by floating the rupee.
On the contrary, my suggestion to the monetary authorities and other economists who work outside the establishment is to understand the nature of the system’s contradiction and develop comprehensive set of policy and administrative tools to steer the monetary system so as to achieve the economic objectives of the nation. Let me give you some clues in order for you to understand the contradiction that I am talking of.
When a household gets richer, it becomes debt free. Do you expect the same thing to happen when a country gets richer? You may say “yes”, but in general opposite happens. Not only richer countries accumulate vast amount of debt, they also accumulate the highest amounts of bad debt too. American economist Hyman Minsky explained that the nature of the capitalist economy is such that it accumulates enormous amount of bad debt as the economy grow and the economy would collapse if the bad debt is not expunged from the system. This was what happened when the U.S. economy and many large economies of Europe collapsed in 2008.
The contradiction is that, when the economy grows the amount of bad debt accumulated in the system increases instead of decreasing. Minsky put the blame on the risky speculators who operate in the financial market. On the previous point he is correct but on the latter point he was wrong. This is where I made an invention in 2008 by presenting a new hypothesis as follows:
“The contemporary economic system can never pay consumers an aggregate income that is equal or exceeding to the value of consumption.” If this is true, what impact it makes in the economic system?
According to the above hypothesis, the economic system is not in natural equilibrium of demand-and-supply and as such, consumers are required to consume beyond their aggregate income in order to have the economic equilibrium. When somebody or a system consumes beyond its income should it begins to accumulate bad debt. This is the reason to accumulate bad debt in the system and differ from Minsky’s perspective. By any chance if consumers began to practice minimalism which idea is promoted by young Japanese, the economy collapses. This means, we can’t live as we want as a whole community. The present system of monetary infrastructure is designed by people and the system we put in place cannot allow us to be debt free at any level of economic growth.
Managing such a system in order to ensure the best possible economic wellbeing is not that simple. When the CBSL does not understand the systemic behavior of the economy, the problem becomes more serious. Intended goals cannot be achieved by adjusting interest rates. Instead, we would achieve better results by keeping the interest rates low and steady, if you can address the issue of inflation, reducing of current account deficit and having good Balance of Payment situation, by employing more prudent set of policy and administrative tools. Ad-hoc measures some time work but not all the time and this proved recently by the U.S., Europe, Japan, Argentina etc. My advise to CBSL is that, do not look for success model/s, but look for right theory and do dare to innovate.