While the majority of the population is busy with various shows going on in the various political parties in readiness for the upcoming elections in May 2019, others are busy doing what matters to their lives— borrowing. Yes, the private sector is borrowing. Towards the end of the year in December 2017, the Reserve Bank of Malawi (RBM) reduced the policy rate from 18 percent to 16 percent.
While this might seem insignificant, it is useful to be reminded that the rate had been adjusted downwards from 22 percent in June 2017 to the 18 percent level in July 2017. As a consequence of this reduction in policy rate, the average base rate for commercial banks was reduced from 31.64 percent in June 2017 to 26.90 percent by the end of 2017. At the beginning of this year, the rate average base rate went down by 2.12 percentage points to 24.78 percent.
The economic theory states that a decrease in interest rates lowers the cost of borrowing, which encourages businesses to increase investment spending. Lower interest rates also give banks more incentives to lend to businesses and households, allowing them to spend more. Oftentimes, due to other reasons, the theory does not match the reality. It is, therefore, important to examine whether the lowering of the policy rate has any impact on private sector borrowing in Malawi. The immediate effect was that, even though the policy rate and the average base rate were reduced in January 2018, private sector credit actually declined consecutively from December 2017 to February 2017. However, private sector domestic credit rebounded in March 2018 and increased by K8.2 billion to K398.0 billion. This was slightly higher than K396.4 billion recorded in March 2017. Does this mean that the interest rate reduction did not have the desired effect? The answer lies in what economists call a lag.
The simplest way to think of a lag is the time it takes between noticing something and taking action. In general, in economics one can classify these lags into several categories. The first is what is called the recognition lag. This is the time it takes for an economic problem to be recognised. Tracking variables in an economy takes time and almost always data is published after the event has happened. Almost all economic indicators are back ward looking. This is another way of saying that economic data at the time they are published reveal a problem that has happened. Take the example of the Monthly Economic Reviews published by RBM. The March 2018 review was published on May 10 2018. This means there was a lag because the data will reveal a problem that happened or started before May 2018.
The second type of a lag is the decision lag. There is a time between recognising there is a problem and making a decision on what to do. Once a problem or a solution has been identified, decision makers will not make a decision immediately for different reasons, which could include legal, administrative or simply due to inefficient systems. So, the decision lag in economics is simply the amount of time it takes for authorities to make a decision regarding how best to handle an economic problem or solution.
Government is a complex organisation, often times with conflicting sections. Even after a solution on a decision has been made, it might take time between the time the decision was made and the implementation of that decision. This is what economists refer to as the implementation lag. This is the third type of a lag.
The final lag is the effectiveness lag, which is the amount of time it takes for an economic policy to have an effect. Even after a decision has been implemented, it takes time for it to work. This could explain why, even though the policy rate was reduced in December 2017, the private sector credit decreased consecutively between January and February 2018 and only picked up in March 2018. Variability and excessive length of lags complicate policymaking in different ways to the extent that, sometimes, a desirable action may be wrong if its effects are felt at a different time than anticipated. This emphasises the need for economic decisions and forecasting to be more accurate. Otherwise, the country will economically lag behind.
Leave a Reply