The consequences of the current pandemic are similar to those of past recessions in terms of low demand and high unemployment. During 2020 millions of people globally either lost their livelihoods. Several countries including the UK, US, Germany, Canada and Russia faced record levels of unemployment.
Rising unemployment, reduction in demand, lockdowns and fear of contracting COVID brought the global economy to a halt. In attempts to overcome this slump and to revive the demand several countries have retreated to the use of interest rates as the magic tool to bring back economies to optimum levels.
Globally, this is not the first time that we have seen reduction in interest rates, ECB turned to negative interest rates in 2015, for the revival of European economies. The Effective Fed Rate started to plunge in August 2019, this was amidst fears that the US economy might face recession. Fed rates are currently at 0.09%. However, in the UK interbank rates are as low as 0.15%. These rates are significant because they form the bases of mortgage rates, lease rates and all sorts of borrowing rates.
Let’s have a look at the implications of artificially suppressed interest rates. As interest rates fall, borrowing becomes cheap, there is more money available in the economy. As money is injected into the economy, buying becomes easy, demand increases and so does and the economy turns towards revival.
But is it as simple as this? Let’s look at it from another angle. When people have more money demand increases, as demand increases so does the supply to a specific level after which commodity prices start to increase. As prices start to increase, we see inflation. Rise in inflation erodes the value of domestic currency and destabilizes the economy in the long run.
Interest rates are one of the monetary policy tools used to control the economy as they have a direct impact on economic growth and inflation. However artificial suppression of these rates can have a multitude of effects including losing the efficiency of monetary policy, bubbles in house pieces, currency depreciation and so forth.
Now let’s look at the interest rate portfolio of Pakistan during the pandemic. Between March 2020 to November 2020 SBP’s policy rates fell from 13% to 7%. At the same time core inflation remained under control. Specifically, in terms of Pakistan’s economy this will rejuvenate the whole system as borrowing will be easy, people will be inclined to start new business, this will create employment and spin a productive wheel ahead. Stock markets are also expected to see further rise. However, volatility is expected to persist due to the instability of Pak Rupee.