Barbados and other regional economies are being warned to brace for spillover effects from the hike in interest rates by the Bank of England, and to focus on putting reforms in place to spur productivity, employment and economic growth.
Reacting to the news late Thursday evening that the UK’s central bank would hike the interest rate to 1.75 per cent along with predictions of a recession ahead in that economy, leading economists Dr Justin Ram and Marla Dukharan told Barbados TODAY they were not surprised by the move, which would have a far-reaching effect.
In a bid to tame soaring inflation rates which have been fueled by a surge in energy prices due to the Russia-Ukraine conflict, the Bank of England’s Monetary Policy Committee voted almost unanimously on Thursday for a half percentage point hike in its key interest rate to 1.75 per cent.
However, Dr Ram cautioned that Barbados and other regional economies should take note, and start making their economies more adaptable rather than react to the external shock.
He said focusing only on short-term measures to deal with the current inflation crisis was not good enough, given that many of the countries in the region have many of the vulnerabilities already in their economic systems before this high period of inflation.
“What the Bank of England has done by raising interest rates, will have a negative impact on their economy and will likely have a negative impact on our economies as well. But it is time for us to stop reacting to shock. It is time for us to start making our economies more flexible and to put in place the type of necessary supply side reforms that spur productivity, growth, jobs and economic growth.
“That is what we need now. We need to spur resilient building from the bottom up, and let us seek to have private sector-led growth and to build resilience from the business and household going all the way up to government levels,” he explained.
Indicating that central banks were responding to a very difficult situation, he believed their reaction was “far too late” and perhaps were also complicit in the environment of very high levels of inflation.
“What we must always remember is that everywhere and in every instance, inflation is a monetary phenomenon. If you have too much money in a system you will eventually get high levels of inflation, and when I say that, if you have excess money in the system chasing too few goods, you will get high levels of inflation,” he explained.
Pointing out that many economists have issued warnings about the very current situation even before the pandemic, Dr Ram said “It is no surprise to me that we have very high levels of inflation now because of this. What is surprising to me is that central banks have not reacted sooner to try to head-off this inflation before we get to this point”.
Dr Ram insisted that fighting inflation required significant economic reforms to spur productivity, and by extension, economic growth.
“I think we need to have policies that are likely to lead to an increase in overall productivity, and an increase in production thereby providing this countervailing force to this over and excessive supply of money we have in the system,” he said.
“This not only applies to countries like the United Kingdom, but as you know, in the Caribbean we have been experiencing many periods of low economic growth and simply because we have failed to implement the types of supply side reforms that are required to spur productivity, to spur investment, and therefore to spur economic activity, growth and jobs, and this I think is the way that we need to start focusing on,” said Dr Ram.
Inflation in the UK was estimated at a high of 9.4 per cent at the end of June and could rise to over 13 per cent by October.
In the case of Barbados, the 12-month moving average increased to 5.8 per cent at the end of June this year, compared to the 1.5 per cent the same period last year.
According to the Central Bank of Barbados, the major drivers of domestic inflation have been food, with significant increases in meat, bread and cereals, oils and fats, dairy and fish.
“High energy prices have also affected transportation and electricity costs and the costs of inputs in the construction sector have also risen sharply,” the recent central bank report indicated.
While governments in the developed economies have been raising interest rates to dampen demand, the Mia Mottley administration has employed a temporary indirect tax reduction method by putting a cap on the Value Added Tax (VAT) on electricity and adding items to the VAT-free basket.
Dukharan, who in June of this year warned that Barbados could expect a dampening of economic activity due to rising food and energy prices and further fall off in visitor arrivals form the UK due to rising inflation in that market, today said raising interest rates was unlikely to have any impact on the rising inflation.
She argued that the inflation being seen was supply driven, based on higher prices of production, particularly oil and gas, as opposed to demand.
“So raising interest rates which the advanced economies are doing apace, but which we are not necessarily doing in the Caribbean except for Jamaica and the Dominican Republic, really does not affect that kind of inflation, because raising interest rates does not change the price of the product on the shelf and the import as the case may be,” she explained.
Dukharan said production prices were simply going up because of higher commodity prices, which was compounded by rising shipping costs.
She further explained that by raising interest rates it “makes the costs of borrowing higher, the cost of living higher and it dampens demands”.
“In dampening demand it means GDP, the size of your economy will slowdown or contract as the case may be,” she said.
“I am not surprised to see this action from the UK, but I am confused as to why the central banks think this is going to help their inflation, it is not,” said Dukharan.
“What it means for us however, is that central banks are having to overreact now and so they are raising interest rates very very quickly to try to head off these very large price increases that we are currently seeing. I am not certain it is going to work, but what it could certainly mean is that it could provide a jolt to these economies, meaning that many of these developed countries can be pushed into recession as their GDPs contract as business and household confidence falls
“It is a pity that we have got here. It means that we have not managed the economic situation diligently and what we are seeing now is that central banks are having to overreact.