Economists Divided Over CBSL’s Decision To Increase Interests
By Hema Senanayake –August 5, 2016
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.
