ON JULY 14, the Banko Sentral ng Pilipinas (BSP) raised interest rates by 75 basis point, and kept the door open for further tightening in the future to keep inflation down.
I would argue, however, that the current economic malaise is beyond the power of the BSP to control.
High interest rates are useful for reducing an overheating economy. Among other things, it forces companies to borrow less, consumers to switch to less expensive goods and generally unwind bad or over leveraged investments.
These things amount to one thing: The suppression of consumption. Less consumption means less inflation. Later, once inflation has cooled off, interest rates can be reduced again, which in turn leads to increased economic activity. And thus, the cycle continues.
Interest rates, therefore, are useful for dealing with inflation in a normal economy. The problem, though, is that we are not dealing with a normal economy. The high inflation we are now facing is being caused by a lot external factors. The situation in the Ukraine, lingering COVID concerns, the global looming food shortage and sanctions against Russian energy exports are things which cannot be controlled by interest rates.
High interest rates cannot create food, energy or fertilizers. They may be great for controlling consumption and borrowing in a stable environment but they cannot be used to create real world commodities.
At best, raising interest rates will help stabilize the economy, but it cannot be used to create oil, fertilizer, food or household consumables. The only way to solve such problems is for the current geopolitical problems to end, and those are not likely to happen anytime soon.
The only bright side I can see in all of this is that the situation could have been a lot worse. Consider for example Sri Lanka, whose government and economy recently just collapsed, or the banking situation in China.
So as bad as the economy might be right now, we should be thankful that we aren’t facing a disaster./PN
