Inflation as a proxy for the economy’s aspirational growth rate

The recent debate about the rising inflation situation in Nigeria and particularly with respect to the recent hike in Monetary Policy Rate (MPR) is proving to be a deterrent to growth. The current Recession may be the proof.

The MPR rate has moved 3 times in the last several months, the latest was the jump from 12% to 14% at the last MPC meeting.

Some of the reasons attributed to why the Monetary Policy Committee ( MPC ) reached this decision included the attempt to  curb rising inflation, slow down the rate  of money going to speculation on the  Foreign Exchange market and also possibly to allow real rates for investors investing in Nigerian government securities.

While these are valid reasons to hike monetary rates, the economic environment and our specific circumstances must be examined properly, and in my opinion the effects neglects what our priority should be at this time.

Inflation in my definition should be seen as a proxy for our actual growth aspiration, that is if we were efficient enough, we will actually grow at the rate of our inflation.

That means our growth rate will equal our inflation rate at any one time. That is, our Current inflation rate of 17%, will also be our GDP growth rate. Can you imagine the national economy growing at 17%? It is possible, if we let inflation be, and push down interest rates sufficiently low to allow this to happen.

Our pursuit of lower inflation at the expense of growth is wrong headed. Not only is it old economies, it is also bad economics, because trying to control inflation with higher interest rates is an unrealistic pursuit. Is anyone saying if inflation goes to 3 digits, we will also push our interest rates to 3 digits?

That is how unrealistic it is to want to set your interest rates with inflation as reference. The new economics is about abundance and choices. Old economics is about scarcity and finite thinking. We must first push for growth at all levels and come back to fight inflation. Our goal should be to outgrow inflation, no matter where the rate is.

When our growth needs are meant, Inflation will find its level with our development matrix and settle eventually near the most efficient levels in the economy. That is why inflation rates are different in every economic environment.

Interest rates are meaningful when they are predictable and stable. While you can set interest rates, you cannot set inflation and FX rates effectively. You must let the market do it more efficiently. Inflation in any environment sometimes looks uncontrollable, but eventually it will find its level.

Even efficient economies like the US also sometimes get it wrong. I was a student in the US in the Jimmy Carter years of Stagflation, where inflation was rising and the US federal Reserve at the time choose to hike interest rates to slow down economic activity in a bid to fight inflation off, the policy back fired and US interest rates went into the double digits which sometime reached 20% . With the economy stagnant and inflation rising, every economic activity suffered. It almost destroyed the US economy.

The most critical element in today’s development economics mix is making capital available to drive growth.

It is ironic that each time the economic growth rates are threatened; in the developed economies they immediately lower interest rates to aid economic growth. They realize that pushing growth is more important than fighting inflation with old tools that also hurts the economy.

The tools are the usual old monetarist model which was, to tighten fiscal and monetary policies which also translate to slow economic growth. Hiking interest rates to fight inflation is a bad idea. Especially in an environment where most of the inflation is imported slower growth rates affect the economy in every way. Our current recession can be explained by the poor reading of the consequences of not acting quickly enough on policies.

The two best policies of this Administration that will help the economy quickly out of the current slump are the flexible Foreign exchange policy and the removal of subsidies from petrol products. They came over one year late. Better late than never! The hope is that the policies will be left alone to achieve its purpose.  If these policies were in place 18 months before, the Naira will not have traded up to N300 to the dollar. Inflation will not be at the levels where it is now.

We should ignore inflation for now, and focus on growth. A slow growth rate would always mean higher unemployment which translates to lower consumer spending, a key part of measuring economic activity in many Advance Economies.

Higher interest rates to fight inflation always end up raising unemployment, and lowering purchasing power for the economy. It even hurts the Government, because they will collect lower taxes. Lower taxes will also mean lower government spending. In an economy where government dominates economic activity, when it does not spend, the economy suffers, that is a reason our current recession has been this severe.

Inflation is a is a figure and a measure of efficiency in an economy. An inefficient Economy will have higher inflation and elevated Foreign Exchange rates, if the growth rates are decent, the productivity of the economy will adjust the key indices of inflation, and Foreign Exchange rates to acceptable rates. The only rate we can control is interest rates. That is why we have to let the other key rates Inflation and Foreign Exchange read the market on their own and find their levels. Interest rates are more impactful and usually set by those who read the economy as they see it and determine what interest rates should be.  Policy makers in their most accurate reading of the economy are more wrong than they are right, because they are reading past data to see the future that is dynamic.

Lower interest rates work for everybody. Lower rates will encourage borrowing by businesses. This will push up employment and overall spending all around.