Explaining Increase In Monetary Policy Rate

By Alexander Nkosi

In most cases people debate with incomplete information. Not that it is bad to debate but we always have to do so with caution because while our arguments could be theoretically correct, they could be wrong when contextualised.

The Bank of Zambia Monetary Policy Committee at its November 2021 meeting decided to raise the Monetary Policy Rate ( MPR) by 50 basis points to 9.0 percent.

This means that interest rates will go up and the cost of borrowing for investment will go up, economic activities will go down and the job creation agenda will be hurt. 

The question is, what is the estimated impact on the economy of the increase in interest rates resulting from an increase in MPR? 

The public does not have this information but experts at BOZ use econometric tools to estimate this.

Now let us look at the flip side. Usually when BOZ is compelled to raise the MPR, it means that there are forces building that could lead to either an increase in inflation or affect efforts to reduce it. So how does high inflation affect the economy? 

It affects both production and consumption as the cost of production as well as the expenditure on consumption go up. It erodes the purchasing power of the currency. 

If inflation is high, you will spend more on buying the same quantity of goods and services, it means that you will spend more and save less. 

There are times when the incentive to save to earn interest is overpowered by the desire to withdraw and spend since the cost of goods and services has gone up. 

Hence, high inflation hurts the economy just like high interest rates do. The question is what is the estimated impact of high inflation on the economy?

So we can see that the decision to raise MPR has both advantages and disadvantages, how then are decisions made? While a layman works with theories only, experts at BOZ work with econometric analysis, they work with numbers. The detailed analysis looks at both sides and helps them decide on the decision which 

So we can see that the decision to raise MPR has both advantages and disadvantages, how then are decisions made? 

While a layman works with theories only, experts at BOZ work with econometric analysis, they work with numbers. 

The detailed analysis looks at both sides and helps them decide on the decision which will best benefit the economy under the given circumstances. 

This goes down to numbers which public debaters don’t have. Also note that MPR is not fixed for the whole year, it can go up and come down the next time it is reviewed, all this is informed by current and projected economic dynamics.

 So BOZ might raise it now to help reduce the negative impact of building forces and reduce it after some months.

In conclusion the decision is arrived at after analysing the current and projected economic fundamentals and asking the two questions: 1)What is the estimated impact on the economy of an increase in interest rates resulting from an increase in MPR? 2) What is the estimated impact of high inflation on the economy? 

Using econometric tools, experts at BOZ weigh the two and make a decision based on current and projected change in economic fundamentals, both internal and external factors. 

So while those complaining about the increase in MPR could have theoretically correct reasons, they lack tools and a comprehensive picture which experts at BOZ and MoF have which necessitated the decision taken, hence there is need to criticise with caution. 

There is close consultation between the monetary policy team and the fiscal policy team before such decisions are taken.

Thank you.