The fight against soaring inflation: exploring innovative tools beyond interest rates hikes


In recent years, Ghana has grappled with a formidable surge in inflation rates, significantly impacting the cost of living for households, escalating overhead expenses for businesses and amplifying government’s cost of borrowing. The inflation rate, escalating from 12.6% in 2021 to a staggering 54.1% in 2022, has prompted a proactive response from the Bank of Ghana (BoG), evident in the substantial rise of the policy rate from 14.5% in 2021 to nearly 30% in 2023.

While this underscores the BoG’s steadfast commitment to quelling inflation, it beckons a critical inquiry into the persistently favoured strategy of relying on interest rates. This article navigates through the intricacies of Ghana’s economic landscape, probing into the implications of such reliance on interest rates and, in tandem, exploring alternative, potentially more cost-effective policy tools.

The Bank of Ghana’s primary objective is pursuing sound monetary policies geared toward price stability while safeguarding the financial sector and payment systems through effective regulation and supervision.

Traditional central banking wisdom dictates that in the face of an overheating economy characterised by surging inflation and consumer prices, the central bank resorts to conventional strategy by raising interest rates. This manoeuvre is strategically crafted to cool down economic activity by making borrowing more expensive, thereby discouraging excessive spending and borrowing – ultimately leading to a reduction in inflation.

This article articulates benefits from the Bank of Ghana’s strategy in increasing its Monetary Policy Rate (MPR) as a means of combatting inflation – revealing its potential to reduce the money supply, elevate the cost of borrowing for both government and businesses, counteract the erosion of real returns caused by high inflation, anchor inflation expectations, render borrowing from the central bank more attractive and potentially attract capital inflows… but crowding out the private sector.

As Ghana grapples with the multifaceted challenges posed by soaring inflation, this article endeavours to unearth a nuanced approach that extends beyond the conventional playbook of interest rate hikes. By doing so, it aspires to provide readers with a holistic understanding of the intricate economic dynamics at play and offer insights into innovative tools that the Bank of Ghana could leverage to navigate the complexities and steer the nation toward sustainable price stability.

The adverse consequences of rising inflation have permeated all sectors of the Ghanaian economy. Citizens are grappling with higher prices for goods and services, while businesses are burdened with unaffordable borrowing costs. Microfinance institutions (MFIs) exemplify this problem by charging exorbitant interest rates, ranging from 6% to 10% per month on loans extended to so-called “unreached businesses”. This practice has stifled entrepreneurial spirit, making it difficult for small businesses to secure financing from MFIs or banks. The prevailing situation has undoubtedly disrupted economic activity and hindered the efforts of numerous entrepreneurs.

It is imperative to understand why the BoG persistently resorts to raising the monetary policy rate as the primary tool to combat inflation. While increasing interest rates can indeed help tighten monetary conditions, there are alternative policy instruments that could be more effective, less burdensome to businesses and less detrimental to the fiscal side.

One such alternative instrument that could be explored is a tiered reserve requirement for banks, closely linked with their surplus liquidity levels. Banks are mandated to maintain reserves with the central bank as a percentage of their total deposits. A tiered reserve requirement system could be designed to make banks with high surplus liquidity hold higher reserves, discouraging excessive lending. Such a system would be more nuanced and targetted.

This way, BoG could increase the CRR (Cash Reserve Requirement) to mop up liquidity at minimal cost rather than pay exorbitantly to mop up the same amount of liquidity from the system in its quest to control inflation. Alternatively, BoG could reduce MPR, increase cash reserve requirements of Financial Institutions, mop up the excess liquidity fuelling the inflationary pressures and at the same time ease pressure on government cost of borrowing from the domestic market through Treasury instruments. Government currently has only the domestic market to borrow from, as the international capital market is shut. Government therefore competes with BoG to borrow from the domestic market.

BoG has over the period adjusted MPR upward, compelling government to equally increase T-bill rates so they remain attractive to investors – particularly financial institutions. The net effect of continuous hikes in MPR is high government borrowing cost as it strives to increases T-bill rates to compete with BoG in attracting funds from the financial institutions. Increasing CRR is the low-cost weapon for BoG to mop up excess liquidity. Reducing MPR and increasing CRR will have the same inflation control effect, but with the CRR presenting a lesser cost burden.

Alternatively, adopting changes to the Cash Reserve Requirement (CRR) presents a viable strategy for the central bank to address challenges of excess liquidity in the financial system without resorting to an increase in the Monetary Policy Rate (MPR). This alternative approach not only aids in effective management of liquidity, but also eases the financial burdens faced by government.

The CRR is a powerful tool in the central bank’s toolkit, and it works by specifying the proportion of their total deposits that banks are required to maintain as reserves with the central bank. This reserve serves as a financial buffer against unexpected withdrawals, and helps safeguard the banking system’s stability.

When the central bank decides to increase the CRR, it essentially tightens its grip on available liquidity within the banking sector. This move has the effect of absorbing excess funds that might otherwise be used for lending and investment. By doing so, the central bank can effectively reduce the money supply and mitigate inflationary pressures in the economy.

One of the significant advantages of adjusting the CRR is that it can be a cost-effective tool. Unlike raising the MPR, which affects borrowing costs across the board and can have broader economic implications, changing the CRR is more targetted. It directly impacts the banks’ reserve holdings without necessarily increasing the cost of borrowing for businesses and government.

This focused approach to liquidity management is particularly beneficial for government. By increasing the CRR, the central bank can mop up excess liquidity in the financial system at a relatively low cost since reserves are unremunerated by the BoG. This in turn eases the pressure on government borrowing funds at higher interest rates, which can strain the fiscal budget and increase costs of servicing government debt.

Moreover, adjusting the CRR can lead to a more competitive environment for lending and borrowing. As excess liquidity is reduced, banks can seek opportunities to deploy their funds more efficiently; potentially leading to a lowering of interest rates in the broader market. This has a cascading effect that benefits not only government but also businesses and individuals looking for more affordable credit options.

In conclusion, Ghana’s struggle with soaring inflation rates has prompted a re-evaluation of the central bank’s monetary policy tools and their impact on the economy. While the traditional approach of raising the Monetary Policy Rate (MPR) has been the go-to method to combat inflation, there is a growing recognition of the need for more nuanced and targetted alternatives.

The adverse effects of rising inflation on everyday citizens and businesses are undeniable. The high borrowing costs and unaffordable lending rates have stifled economic growth and entrepreneurial initiatives, making it imperative for the Bank of Ghana to explore alternative measures. One such alternative is adapting the Cash Reserve Requirement (CRR), a strategic tool that allows the central bank to manage liquidity effectively without imposing a blanket increase in interest rates. This approach not only absorbs excess liquidity but also alleviates the financial pressures on government – reducing cost of borrowing and improving the fiscal outlook.

Furthermore, the CRR approach fosters a more competitive lending environment, potentially leading to lower interest rates and broader access to credit for businesses and individuals. This contributes to a more balanced and prosperous economic landscape in Ghana.

In the pursuit of price stability and sustainable economic growth, it is essential for the Bank of Ghana to consider and adopt a diversified set of policy instruments. The combination of interest rate adjustments, CRR management and other tools like open market operations provides a more comprehensive and flexible approach to achieving economic stability.

Ultimately, the effectiveness of Ghana’s monetary policy relies on the central bank’s ability to balance need for inflation control with the imperative of fostering economic growth and financial stability. The evolving landscape demands an exploration of innovative and targetted tools, such as the CRR, to ensure inflation is managed cost-effectively while facilitating economic prosperity for all.

The writer is Relationship Manager-Commercial Banking, Stanbic Bank

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