Author Topic: Should BB reduce interest rate?  (Read 380 times)

JEWEL KUMAR ROY

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Should BB reduce interest rate?
« on: May 26, 2015, 06:44:01 PM »
The debate is whether the Bangladesh Bank (BB) should take measures to decrease interest rate. The traditional outlook has been that the central bank should take such measures whenever the necessary and proper situation arises. This necessary and proper situation is not very clear-cut either. Professor M. A Taslim in an article published in The Financial Express on May 21, 2015 has questioned the approach of the BB as regards decreasing interest rate. He mentioned that BB had a significant role in creating the 2009-10 stock market bubble by decreasing interest. If this argument turns out to be valid, then why has BB taken such a dreadful step once again?  Moreover, Professor Taslim offered convincing argument in support of the view that BB shouldn't interfere in interest rate. The situation that urged BB to take such a step is the depressed market. But whether market is actually depressed or reflects the optimal correction state is not very clear.  The reason is that the central bank is a single entity, and it can't by any means not only fix interest rate but also determine in which direction it should move -whether to raise or decrease interest rate. To determine an interest rate that will not disturb market and restore equilibrium, central bank would have to possess omnipotent power having every kind of information under its command. But this is hardly the case, and the central bank is just an entity among many others operating in the market, and other entities possess a variety of information that the central bank doesn't have at all.

More than half a century ago, Frederick Hayek raised this issue in an article (The Use of Knowledge in Society, 1944). In that article Hayek argued that: "The peculiar character of the problem of a rational economic order is determined precisely by the fact that the Knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate given resources …. It is rather a problem of how to secure the best use of resources known to any members of society…. Or to put it briefly, it is a problem of the utilisation of knowledge not given to anyone in its totality."

If we closely analyse Hayek's statement, we find the following two most critical things: ( a) Knowledge never exists in concentrated and integrated form but in dispersed bits. (b) Dispersed bits of knowledge are not possessed by any entity in totality but by every entity.

If Hayek's statement carries any significant meaning, it carries perfectly the message for centralised control of economic problems and matters. Hence, a critical message for central bank as well. Hayek's statement readily shows how much justified it is to say that the central bank should control the interest rate. In fact, interest rate is not a single rate but a composition of diverse rates to which each entity is subject to. Each rate carries a different information and signal of different circumstances and different economic knowledge. If the central bank were to control the interest rate, then it would have to be an omnipotent institution in the know of all information which is totally impossible.

In this short exposition, we will show the following things: (1) Every time the central bank manipulates the interest rate, it is more likely that the central bank will find that its rate either falls below the equilibrium rate or stands above the equilibrium rate. And that creates troubles for the economy. Here by the term, 'manipulating interest rate', we mean a direct control on the interest rate, for example, direct slashing of interest rate. (2) Whether the difference between the interest rate manipulated by the central bank and the real equilibrium rate will be zero, is a pure chance and this chance has no predictable aspect. (3) If the central bank were to control interest rate, the only way it can do so without disturbing market equilibrium much is through applying the qualitative slashing of interest rate, not the quantitative slashing of interest rate.

If we take it for granted that the central bank doesn't possess all the information that is necessary to determine the interest rate so that it should match the market equilibrium rate, then we can give answer to our first point that, every time the central bank manipulates the interest rate, it either falls below or stands above the equilibrium rate. To show that, we can imagine a situation in which a pure market equilibrium rate is given - in fact it is not given but can be conceived - and a manipulated rate by the central bank is also given. We also think that market equilibrium rate of interest is determined by some factors given some constraints.

The view that market is depressed is not an excuse at all. In fact, market is revealing what it should. Market is depressed to the extent needed to reach downward equilibrium. One misconception that still stirs public mind is that depressed market means market is in troubled and disequilibrium state. The statement is not fully wrong. What is wrong with this statement is that in the current context of our country, market is not in downward disequilibrium. In fact, it is in equilibrium keeping in mind the kind of damages done to our economy and degree of uncertainty that prevails in the whole economy. An article published in The Financial Express on May 22, 2015 has clearly demonstrated the exaggeration in the estimation of GDP (Gross Domestic Product). The writers pointed out those loopholes which cause the exaggeration in estimation due to the use of outdated data and improper methods. If we take this into our consideration, then BB should once again reassess its decision to reduce the deposit. It is more desirable that BB acts as a neutral entity that doesn't bear the burden of others. If the economy is in troubled state due to political damage, the responsibility of recovering the economy from that trouble doesn't in any way fall on any department of BB. BB should stay out from this economics of politics.

Offline ummekulsum

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Re: Should BB reduce interest rate?
« Reply #1 on: May 27, 2015, 12:37:16 PM »
informative post :)

Offline Shah Alam Kabir Pramanik

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Re: Should BB reduce interest rate?
« Reply #2 on: May 27, 2015, 06:12:49 PM »
Thanks  for providing valuable information.


Offline Reza S. H.

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Re: Should BB reduce interest rate?
« Reply #3 on: May 28, 2015, 02:27:24 PM »
At this current state of market, BB should reduce it certainly. Unless the economy goes well again, it should cooperate the well being of its country pupil.

Offline Tofazzal.ns

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Re: Should BB reduce interest rate?
« Reply #4 on: May 30, 2015, 07:30:50 PM »
Thanks to share informative post...
Muhammad Tofazzal Hosain
Lecturer, Natural Sciences
Daffodil International University

Offline Nusrat Nargis

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Re: Should BB reduce interest rate?
« Reply #5 on: May 31, 2015, 02:46:22 PM »
thanks for sharing.
Nusrat Nargis

Assistant Professor
Department of Business Administration
Daffodil International University

JEWEL KUMAR ROY

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Re: Should BB reduce interest rate?
« Reply #6 on: June 02, 2015, 01:15:48 PM »
Thanks for your comments...  :)