15 November, 2018

Blog

The Central Bank Increased The Interest Rates!

By Hema Senanayake

Hema Senanayake

Hema Senanayake

The Monetary Board met on July 28, 2016. On that meeting the Monetary Board decided to increase the main interest rates of the Central Bank. Accordingly, what is known as the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR), have gone up by 50 basis points each, to 7.00 per cent and 8.50 per cent, respectively with immediate effect. The resultant effect of this decision is that the market interest rates will go up. Why did they do it? On the same day, the central bank issued a press release explaining as to why the Monetary Board took this decision.

According to the press release, we can presume that the Monetary Board had three main concerns in taking this decision. The Board intends to keep the inflation rate at mid-single digits and secondly, the Board wants to contain the widening trade deficit and thereby support the balance of payment situation. This decision making process is interesting and could appear logical, but unfortunately it is not so. Hence, the resultant effect could be that the central bank would not achieve what it wants to achieve namely the above mentioned three objectives. Why do I say so?

With a view to simplify my answer, now, I invite readers to participate in making the decision made by the Monetary Board. Let us begin it. If there is a certain simple parameter in the economy which parameter correlates to inflation and to the trade deficit then you could change the inflation rate and the trade deficit by changing that parameter. Since, the Balance of Payment is strongly linked to the trade deficit, if any economic parameter changes the trade deficit then that parameter effectively correlates to the Balance of Payment too. It means that, if there is an economic parameter that could change the inflation and trade deficit, then that parameter could effectively change the Balance of Payment situation too. So far it is simple. I assure you that it will remain simple until the end of my argument.

Now, you are told that private sector credit growth is the economic parameter which correlates to the said three variables, namely, inflation, trade deficit and the Balance of Payment. This means that, if you allow private sector credit to grow, and as a result the inflation might increase, trade deficit might get widen resulting to have negative pressure on the Balance of Payment. Conversely, they might say that if the private sector credit growth is contained or reduced, then the inflation might be reduced, the trade deficit might also be reduced resulting positive effect on the Balance of Payment. So, private sector credit growth is the important parameter. Based on this information, what decision you want to make now? You may decide, in favor of the reduction of private sector credit growth, so that you might expect to contain inflation and to reduce trade deficit which would result in having positive impact on the Balance of Payment. Yet, there is one more step in this process.

Then, again you would further be informed that, if you increase the rate of interest, then people would borrow less and less and as a result private sector credit growth would be reduced. As you may see, now, it made simple, you would decide to increase the rate of interests, as was decided by the Monetary Board, so that private sector credit growth would be reduced in achieving the reduction of inflation and trade deficit; reduced trade deficit would support the Balance of Payment situation as mentioned above. It seems all very logical but not so. What is the problem?

The problem is that it is not the private sector credit growth that matters, instead the total domestic credit growth is what matters and the total credit growth does not purely depend on the rate of interests. In fact the total domestic credit growth is something that depends on a lot of variables. I repeatedly insisted that the central bank lacks certain important policy tools to contain the credit growth without increasing the interest rates. Keeping market interest rates low would reduce inflation than increasing the rates to keep inflation low.

The formula I am proposing is that the central bank must acquire a few more policy and administrative tools in order to steer the monetary system to achieve national economic objectives. At least, the central bank might need a new policy tool to regulate the growth of “credit money” in the system and to partly change the ownership of the official foreign exchange reserve without infusing new money into the system. Perhaps, somebody might now question me to provide empirical evidence to support my proposal. This is a point where a paradigm shift takes place. Until the paradigm shift takes place no one can provide empirical evidence. The empirical evidences belong to old practice. What we need is a new practice of central banking.

Print Friendly, PDF & Email

Latest comments

  • 11
    0

    What kind of nonsense is this guy on about NOW, and why does this site keep publishing his garbage? Finally unable to find fault with the latest decision, despite masking it in a bunch of pseudo-economic tripe, and unable to provide empirical evidence, he introduces such hackneyed phrases as ‘paradigm shift’ etc. It is getting hard to discern between Hema Senanayake and Rohantha Athukorala now!

    Central Banking is not a place for experimentation and paradigm shifts. Leave that to the theoretical models that never leave most economists journal articles. We have a country to rebuild here. If you have anything worthwhile to add then come here and put it in action, but spare us the misery of your jealous overtones.

    • 1
      2

      Amen brother!

  • 10
    0

    Mr.Senanayaka: You say, “What we need is a new practice of central banking”. Why don`t you propose one? Why didn`t you say this when that rogue Kabaraala was acting as if he was the sole proprietor of the central bank?

    • 2
      0

      Diogenes,

      Hema says,

      “The formula I am proposing is that the central bank must acquire a few more policy and administrative tools in order to steer the monetary system to achieve national economic objectives. At least, the central bank might need a new policy tool to regulate the growth of “credit money” in the system and to partly change the ownership of the official foreign exchange reserve without infusing new money into the system. Perhaps, somebody might now question me to provide empirical evidence to support my proposal. This is a point where a paradigm shift takes place. Until the paradigm shift takes place no one can provide empirical evidence. The empirical evidences belong to old practice. What we need is a new practice of central banking.”

      I propose to implement a mixture of asdfjkl; and abrekadas theories with some parts from “quick brown fox jumped over the fence” theorem integrated to same to be implemented for easing out of the economic burden of the country. In conformity of recommendations of Hema we could just as well borrow some special sexeoconomic tools from unmarried girls which they use for scintillating their pleasure regions at night. I am sure this will rejuvenate our economy with more girlie oil boy thrust!

      This baana WA Wijewardena and Hema criticized Arjun for increasing the interest rate of government borrowings. Now C’swamy whom they considered to have descended from heaven to replace AM has implemented the 2nd stage of interest rates adjustment which I think is reality adjustment to what hitherto artificially controlled gilmart economic practice of MARA! Now is this all what you have to say about the correction-the “special tools” that only exist in paradigm shifts, crank shafts and differentials in fucked up arm chair theoreticians? AM must be smiling in his buttocks now!

    • 6
      0

      ‘paradigm shift’

      as long as Ranil is the driver `he would leave the rest to the gods.`

      `credit money`

      still there is excess sLR floating around??

      surreal thing….

      TED

  • 15
    0

    In the mid 1970s, I was a youngish Economist then on secondment to the Federal Reserve Bank of New York (essentially, the ‘Central Bank’ of the USA) from the then Ceylon Civil Service (I forget if it had recently transitioned to Sri Lanka Administrative service at the time). I was cordially acquainted with Roving Raju (father of current governor of the CBSL Dr. Indrajith C.) and Charlie Mahendran, father of the former governor of the CBSL, Mr. Arjuna M. as both were fairly senior public servants at the time. Dr. Coomaraswamy must have been finishing his education or entering the CBSL (he is by some years my junior) where as Arjuna Mahendran must have been in school at the time. I have no idea who the author of this article Mr Hema Senanayake is, or his whereabouts at the time, but I suggest he relook at that point in economic history as to what was going on in the USA back then.

    In the late 1970s, the USA was going through its highest inflation in recent decades. We are talking numbers between 12 to 15% per year. President Gerald Ford was voted out of office after silly campaigns like “Whip Inflation Now” (WIN), which he did not win, instead losing the popular vote as well. His successor, Jimmy Carter, had only one choice for the Chairman of the Federal Reserve Bank (most of the nominees refused), after a similar saga as the one we saw at the CBSL recently. This is because nobody wanted to be the Chairman of the Fed at the time, because it was the fast route to becoming the most hated man in America. Inflation was fuelling hitherto unseen rises in prices in the property markets and the value of peoples savings (there was no longer a point in saving) was eroding at a rate.

    For the uninitiated, let me explain in basic terms what inflation is, in very very simplistic terms. Imagine you are on a deserted island that only has the following: 1) 1000 coconuts 2) 1000 one rupee coins. Bank savings rates are at or near 0%. Let us assume that the price of each coconut is set at 1 rupee. Simply put, we now have the capacity to buy all 1000 coconuts with the money we have. Now let us assume that all of a sudden a helicopter appears and drops another 1000 one rupee coins on our heads. All of a sudden, there is more money in supply, but the number of coconuts has not increased. This sudden increase in money, artificially created, is better known as Quantitative Easing (QE). This causes the coconut merchant to now raise his price to 2 rupees per coconut. This cycle continues, until, before you know it, prices have spiralled out of control, driven by:

    1) The additional money (M1) in the system that is increased each time the helicopter flies overhead (in real terms, additional money in the economy created by central banks)
    2) People buying now because they think prices are going to rise, thus increasing demand, thus reducing supply, thus increasing prices…you see where this is going?

    The one man who convinced Jimmy Carter he could put a stop to this was Paul Volcker, the 6 foot 7 economist who took over the Federal Reserve bank, and became America’s most hated man. Until, almost two years later, he became the national hero, after the drastic measures he took not only sparked off a recession but put unemployment up to almost 14% before things corrected themselves. The only reason from the delay in correction after implementation was simply the behaviour of people. They did not expect inflation would reduce, so they continued as if nothing had changed, thus driving inflation up. Until, one day, they finally believed it, and inflation stopped.

    What people like Hema Senanayake and even reputed economists with their theoretical and abstract models do not realise is that most of the causes of economic crises are driven not (purely) by manipulating interest rates and hoping for the best, but, rather, by being able to influence consumer behaviour so that it fulfils the direction that the monetary policy hopes to steer the country in. The issue with all of these pundits today is that none of them are willing to admit that the real results are all in the hands of the consumer, and these monetary games can amount to little unless the media is properly utilized to bring about that needed change in behaviour. When people BELIEVE something is going to happen, they behave accordingly, thereby fulfilling that cause. I have yet to see this portrayed through any of these punditry articles, and is why I find these talks about ‘paradigm shifts’ nonsensical. There is no need for paradigm shifts when there is ENOUGH empirical evidence from countries who have been through far worse in the past and have managed to succeed purely through bold steps.

    The US inflation rate today? Less than 1.5%

    If you’d like to read more about what Paul Volcker did, I suggest you look up the many books and documentaries, as well as scholarly articles, of that era.

    • 0
      4

      Elder Statesman,

      And after that, capitalist oligarchy took over America – guns, medical drugs, military complex, nuclear arms race, GMO monopolies etc. infected America and the whole world. US, being the world’s reserve currency, is able to do anything they like with their economy, including printing of money, and always pull it off. Rich became richer, and poor have only a little voice.

      Now Sri Lanka is a different story. What we need is socialized capitalistic democracy. And that means keeping interest rates low so the masses can tap into loans, and build up the economy from ground up.

      The suggestion from Hema Senanayake that central bank must have a few more policy and administrative tools in order to steer the monetary system to achieve national economic objectives, includes banks lending out to customers at honorable and legitimate reasons.

      We hope the film Kabali that is showing all over Sri Lanka, and even here in the US , won’t be the new paradigm of gangsterism, that is going to run our economy, via Tamil diaspora bonds via Malaysian bank (with palm oil plantations to complete the greenery). Lanka’s ancient heritage is doomed!

      • 2
        0

        Why don’t you abandon America and move to Sri Lanka then, if it’s as bad as you say?

        • 2
          2

          because America won’t make it easy of our countries, will they…..America will always do well by hook or crook. It’s up to our leaders to be diplomatic and make better deals with America for Sri Lanka’s honorability…glad I am here to see things with better perception.

  • 2
    1

    Very Interesting argument Mr.Senanayake.
    Economics is an Empirical science;So,there are so many possibilities with increasing/reducing Interest rates;Quite unlike Mathematics!

  • 1
    1

    Good opinians

  • 0
    6

    Keep the private sector credit rates low, and the masses will borrow and thrive on what’s already there, without further borrowing (loans paid back very fast). Sri Lanka will be a self –sufficient island building on her own money and recourses. But this is a no-no to the powers-that-be. It is imperative to them, that we borrow their money and keep the cycle going.

    Masses have to dependent. Only elite sector will have the recourses to sell the country to outside forces, so outside force’s money will infuse the Island.

    We all know they are also intent in raising interest rates to infuse certain diaspora money into the Island. And they will infuse at whatever the interest rate is.

  • 2
    2

    The problems is not the Central Bank or the economists there. It is the Sootin and Martin duo at the top. There naivete followed by incompetence have made all economic activities to come to a halt. Sootin’s belief that West will give him shit loads of money at Robin Hood rates did not materialize. And Martins assertion that hijacking the party leadership will result in mass following has come to naught. Today the Government has lost it’s credibility that they have the capacity to Govern. The crowds on the Kandy Colombo Road following MR are not his slaves. They are the millions who are disillusioned by the Yahapalana tom pathca. MR is on a rise only the Diaspora Coolies and Sooting and Martin that do not want to see it.

    • 5
      0

      The crowd of around 3500 people consists mainly of those from villages along the way who are given three meals and some money to drop in and out. I know this because I know some of them.

      Money from the west seems OK since our sovereign bond issues have been successful this year. BOI agreements are also at an all time high although it takes a couple of years at least to realise cashflow. At least now there is transparency and we know what the problems are rather than living in fantasy land like in the MR era. If you have a solution for the debt problem then why dont you do something about it?

    • 3
      1

      Patriot,

      Bagehot,

      Machang ahapan oya Rajage ate ellila inna oya uda inna ekagen okage maha eka mona magulatada two years kalin kelawagaththe kiyala! Moo mona puke amaruwatada danne naa dan kakul kadenakan pada(da) gaman yanne! Good miharak bana, Mara fucker and patriot fucker! Mun denna ape kumbura hanna hondai, Nittambuwa dihadi allala welata daganna ona.

    • 0
      0

      My Ass,
      Where did you find millions people Fallowing a Killer wild asses who ruined sri lanka.
      4000 -5000 people who send by thieves around Killers are millions??????

      • 1
        0

        Julampitiye Amaraya spend your life sentence peacefully in Welikada.

  • 3
    0

    The moment somebody introduces more and more tools to the central bank, ruining the economy starts. All what we need are very plain old simple rules. Consumer behaviour is the mostly unpredictable parameter in economy due to various factors. One such factor is the modern innovations that come to markets at an unbelievable speed.

    No tools that can do paradigm shifts should be introduced to any central bank anywhere.

Leave A Comment

Comments should not exceed 300 words. Embedding external links and writing in capital letters are discouraged. Commenting is automatically shut off on articles after 10 days and approval may take up to 24 hours. Please read our Comments Policy for further details. Your email address will not be published.