Doughnuts for Monetary Policy
Economy, Opinion

In 2012, one of America’s most prolific hedge fund managers, David Einhorn of Greenlight Capital published an intellectual and intriguing piece in the Huffington post, challenging the reflexive and conventional monetary economics. In his piece David argued against a continued easing of monetary policy that the Federal Reserve Bank of America was pursuing at the time to spur economic growth and shake off the effects of the financial crisis of 2008. ‘A jelly doughnut is a yummy mid-afternoon energy boost. Two jelly doughnuts are an indulgent breakfast. Three Jelly doughnuts may induce a tummy ache. Six jelly doughnuts – that’s an eating disorder. Twelve jelly doughnuts is fraternity pledge hazing.’ He noted that, instead of a robust recovery, the economy would continue to be sluggish.

The Bank of Zambia, has been easing monetary policy since February, 2017. According to the MPC calendar, the Bank of Zambia monetary policy committee will be having its first quarter meeting for this year, on the 14th to 15th May, 2018. Tracking the policy rate easing from the last three consecutive MPC meetings it shows that from August, 2017 a reduction of 150bps was made from 12.5% to 11%, then November, 2017 a further reduction of 75bps, 11% to 10.25% and finally February, 2018 a 50bps reduction followed, from 10.25% to 9.75%. Correspondingly, the banking sector’s statutory reserve ratio has also being reduced synchronously. The central bank pursues an inflation-targeting monetary policy, where they utilize the monetary policy tools to achieve a certain inflation target and maintain price stability. In order to achieve a targeted 5% GDP growth and single digit inflation of 6% to 8%, BOZ has continued to ease monetary policy to loosen the flow of money into the economy.

However, low interest rates can have adverse effects especially when other economic factors do not play along. Low interest rates encourage businesses and consumers to borrow and purchase things. Loans put money into circulation and raise money supply, which supports economic growth – to a point. Beyond a certain point lower rates can also be a damper on the economy and business growth. When savers cannot earn attractive interest income on their savings and fixed term deposits, they either use the money to pay down debts or invest in several asset classes like stocks and real estate. Low interest rate also affect insurance companies that rely on a certain interest-based return on the money they receive in premiums to support their coverage liabilities, so the insurance premiums may rise. Thirdly, when interest rates are abnormally low, banks don’t have high deposit base, in turn it becomes difficult to finance small business operations that lack collateral hence sluggish growth.

Thirdly, there’s a possibility of a liquidity trap. A liquidity trap happens when interest rates are so low that they don’t serve normal functions of spurring the economy to growth. Instead they reduce the flow of money to the real economy because it goes into investments in assets that do not produce employment such as the stock market and paying down loans.

Finally, there’s potential for inflation later. The risk of recovery from a liquidity trap is inflation if the central bank doesn’t mop out enough money from the system as money comes out of assets and enters circulation in the business and consumer economy.

If I were to predict the next course of action by BOZ I would be inaccurate. Rather, I would like to see a no-change in both the policy rate and statutory reserve rate to avoid diminishing returns to the economy. BOZ Governor Denny Kalyaya’s economists certainly be considering some of the points that I have presented. For now, I will sit back and have one or two doughnuts as MPC deliberates.

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