No central bank can keep low interest rates and defend the exchange rate at the same time without allowing for capital outflows in terms of the ‘Impossible Trinity’
It was with some amusement that I read the article titled ‘Interest rate policy: Is it a punitive measure?’ written by Chandrasena Maliyadde, which appeared in Daily FT last week (http://www.ft.lk/columns/Interest-rate-policy-Is-it-a-punitive-measure/4-717719). It is a critique of my article ‘Low interest rate policy punishes savers’ published in this column on 25 March (http://www.ft.lk/columns/Low-interest-rate-policy-punishes-savers/4-715286).
While welcoming the criticism, I am compelled to mention here that his article contains nothing but numerous sarcastic and sweeping statements without any theoretical or empirical foundations which are essential features of any sensible economic analysis.
The writer has not presented a single fact or a figure to prove his viewpoints, which seems to be his usual writing style despite being Secretary to three Ministries before retirement. His article contains many factual errors and inconsistencies as well.
Nevertheless, I must thank him for prompting me to elaborate my arguments on the critical issues of interest rates and savings once again in this column, and to dispel his misconceptions.
Mercy towards the poor?
In his article Maliyadde states, “I read with a lot of interest the article on ‘Low-interest rate policy punishes savers’ by our good friend Prof. Sirimevan Colombage. He has shown a great deal of mercy towards the poor and ageing community. I wonder whether ageing has disturbed his brilliant thought pattern. He talks more of spiritual aspects of life (mercy and thriftiness) rather than the discipline of materialistic economics (greed and investment) that he mastered throughout his career as a central banker, an academic and a researcher.”
In response to his statement, I would like to point out that I never expressed any views in my article on “spiritual aspects of life (mercy and thriftiness)”.
It was purely a theoretical and data-based presentation that highlighted how the Central Bank’s low interest rate policy has adversely affected savers by offering them near-zero real interest rates while failing to stimulate commercial bank credit to the private sector so as to revive the COVID-19 pandemic-hit economic activities, as expected by the authorities. Instead, the Government and public corporations have been able to borrow heavily from banks at low cost, taking advantage of low interest rates and easy money policy. This has resulted in an increase in the money supply by 22% during the last 12 months, causing enormous damage to macroeconomic stability.
Neglect of macroeconomic implications
Maliyadde has completely neglected the macroeconomic implications of the excessive money supply growth in the recent past fuelled by unprecedented Government borrowings along with low interest rates.
Besides, no central bank can keep low interest rates and defend the exchange rate at the same time without allowing for capital outflows in terms of the ‘Impossible Trinity,’ as I reiterated in this column. These are the points that Maliyadde missed in his write-up. I concluded my article by emphasising that fiscal and monetary policies need to be reformulated within a cohesive macroeconomic framework aiming at sustained economic stability without resorting to fixed interest and exchange rates.
Ignoring such broader insights contained in my article, Maliyadde laments that I have shown mercy towards the poor and ageing community.
Article based on positive economics
I have been cautious throughout my career to base my research work strictly on ‘Positive Economics,’ as taught by my guru, the late Prof. H.A.de S. Gunasekera at Peradeniya University.
Statements can be classified into positive statements and normative statements. Positive statements concern “what is, was or will be”, and normative statements concern “what ought to be”.
Positive statements are based on theories, hypotheses, data, models, empirical tests and simulations. In contrast, normative statements are drawn from one’s philosophical, cultural, ethical and religious positions. They depend upon one’s judgement about what is good and what is bad. In other words, normative statements depend on “value judgements”.
Disagreements over positive studies can be tested, proved or disproved by using statistical tests whereas disagreements over normative statements cannot be settled in such manner as different individuals have different ideas of what is good and bad.
My article was based on positive economic foundations supported by Monetary Theory and quantitative data, and therefore, its findings can be accepted or rejected objectively by evaluating the given empirical evidence.
Maliyadde, however, has not made any such attempt to assess whether the present low interest rate policy punishes savers, which is the core theme of my study. Instead, he has taken the easy path to present sarcastic narratives with lots of unrelated issues without focusing on the core subject matter.
Hence, his article, based on his own value judgements, could be placed in the normative category, and, it cannot be evaluated by using any of the standard economic tools.
Critic’s ignorance of welfare economics
Maliyadde states that he is wondering whether ageing has disturbed my thought pattern to shift to spiritual aspects of life (mercy and thriftiness) from materialistic economics (greed and investment). This statement itself reflects how the weakness of his understanding of basic economics.
In my article, I explained how the Central Bank’s low interest rate policy has adversely affected savers, specifically those who are in the bottom of the income pyramid. Such issues relating to poverty and income distribution are well within the scope of Welfare Economics, which is a branch of economics that seeks to evaluate economic policies such as interest rate policy in terms of their effects on the wellbeing of the community.
He thinks that talking about the plight of the poor is a spiritual matter. Besides, the writer has misinterpreted savings (which we learnt as a key macroeconomic variable during our undergraduate days) as a spiritual aspect of life vis-à-vis investment which he considers as a materialistic economic norm.
Taking U-turn to be an anti-liberalisation champion
Maliyadde, who served the ‘Yahapalana’ Government in the Ministry of National Policies and Economic Affairs, which launched the pro-liberal economic strategy for Sri Lanka, ‘Vision 2025’, has now taken a U-turn by pausing himself as an anti-liberalisation champion.
In his write-up, Maliyadde blames economic liberalisation for each and every ill in the society. His long list of liberalisation-led ills includes birth control, low fertility, poverty, income inequality, disintegrated families, regional disparities, rural-urban imbalance, multiple ministries, multiple lotteries, population ageing, low agricultural and industrial production, erosion of rural economy, imports (cosmetics, grapes, apples, jumping-fish textiles, liquor and cigarettes, expensive cars), shifting of girls from handloom to power-loom industry and boys from traditional to modernised agriculture, girls’ insecurity, child malnutrition, illicit drugs, private practice by doctors, abortions, curative medicine in place of primary healthcare and so on.
It is not clear how those arbitrarily chosen items are relevant to the ‘low interest rate policy and savings’, which was the theme of my article fired by the critic.
Some of the statements in the writer’s article make us confusing, and they are hardly relevant to the subject matter of my column – interest rate policy. For example, he says, “Some health centres promote births during day time and abort births after dusk. Eliminating a birth has become more lucrative than saving a birth. The liberal economy offered two options; save a life and save money; eliminate life and make money. Liberal economists are economic doctors but not medical doctors.”
Shedding tears for savers?
Maliyadde states, “Liberal trade and liberal economy advocates expected or misbelieved that it would bring investment, revenue from tourism and exports and accelerate growth and generate more employment opportunities. But it has endowed us an import-dependent lagging economy with an army of dependents. It is not the fallout but it is the total result. They now shedding tears on the plight of savers to cover their failure.”
Instead of shedding tears as mentioned by the critic, I clearly pinpointed the causes of the failure of economic liberalisation policies in Sri Lanka in my article as follows:
“My understanding is that successive governments have faced multiple challenges in adopting the much-needed macroeconomic corrective measures such as containing the budget deficit and maintaining flexible interest and exchange rates over decades. The inability of the authorities to tackle such challenges has resulted in the failure to reap the benefits of economic liberalisation. Hence, the main reason for the failure to achieve economic success seems to be the authorities’ inability to tackle the policy constraints, rather than the weaknesses of the orthodox recipe [economic liberalisation] per se.”
Critics of economic liberalisation deliberately neglect the fact that Sri Lanka’s economic stagnation is caused by factors such as policy failures, institutional weaknesses and political instability, rather than liberalisation. Specifically, the populist economic policies adopted by the successive Governments in the annual Budgets to please the voters to win elections have had detrimental effects on economic efficiency and growth. Opponents ignore these political economy factors and continue to blame economic liberalisation for the country’s economic downfall.
Low investment efficiency
More importantly, the country’s investment efficiency has deteriorated considerably over decades due to technology and innovation backwardness and less-productive public investment on major infrastructure projects, as discussed in my FT column appeared last week (http://www.ft.lk/columns/Investment-efficiency-crucial-for-post-pandemic-economic-recovery/4-717652).
The widely-publicised corruption involved in the selection and implementation of such projects further weakens investment efficiency. The writer completely ignores those policy and implementation-related weaknesses, and blames economic liberalisation for the calamity.
Praising pre-1977 economic policies
While brutally criticising the post-1977 economic liberalisation policies, Maliyadde has taken extra care to praise the pre-1977 inward-looking policies displaying his new-found love with import controls, protective domestic industries and subsistence agriculture,
He says, “The economic system that prevailed before the introduction of a liberal economy, whatever you named it, was inclusive and catered to all segments of the population. The family was a single integrated unit. But liberalisation disintegrated the family and divided as women, youths and children. Widening income inequality created poverty. The widening gap created regional and rural/urban imbalance.”
In contrast, many country studies conducted since the 1970s provide ample empirical evidence against import substitution policies (promoting industrialisation by import controls) in favour of outward-oriented policies (trade liberalisation accompanied with free movement of capital, labour, technology and enterprises). The most prominent among them is the study series conducted by the US National Bureau of Economic Research (NBER) under the direction of Anne Krueger and Jagdish Bhagwati in 1978.
Can’t the poor afford to save?
Maliyadde states, “Colombage laments that the low-interest rate has punished poor savers by offering low yields for their lifetime savings. Who are these poor savers? Can the poor afford to save? There are poor debtors and rich savers in society. A high-interest rate would offer a higher income to rich savers and high prices to poor savers, widening the already existing income inequality, which is another achievement of the liberal economy.” According to Maliyadde, poor people never save, and they only borrow. Rich people are the only savers, according to him. Hence, the low interest rate policy helps the poor to borrow at low cost, and it has no adverse impact on them since they do not save. The rich are the ones adversely affected by low interest rates, asserts the writer.
Saving by the poor through microfinance
Maliyadde, who excelled in public service for a long time, has to do some reading in microfinance at least now to see the success stories of savings by the poor in developing countries and how millions of them crossed the poverty line by managing their low incomes, specifically in Bangladesh.
Based on their field studies conducted in Bangladesh, India and South Africa using “financial diaries”, Daryl Collins, Jonathan Morduch, Stuart Rutherford and Orland Ruthven, in their book ‘Portfolios of the Poor: How the World’s Poor Live on $ 2 a Day’ (2009) elaborate how the poor manage to save a part of their little income, and gradually improve their livelihood using innovative financial instruments. Those findings contrast with the general belief that with incomes at impossibly low levels, the poor can do little for themselves beyond hand-to-mouth survival, as assumed by Maliyadde.
Collins et al. state, “Given this gap in our knowledge and our own accumulating questions, several years ago we launched a series of detailed, yearlong studies to shed light on how families live on so little. Some of the studies followed villagers in agricultural communities; others centred on city-dwellers. The first finding was the most fundamental: no matter where we looked, we found that most of the households, even those living on less than one dollar a day per person, rarely consume every penny of income as soon as it is earned. They seek, instead, to ‘manage’ their money by saving when they can and borrowing when they need to. They don’t always succeed, but over time, even for the poorest households, a surprisingly large proportion of income gets managed in this way—diverted into savings or used to pay down loans.”
Sri Lanka’s experience in saving by the poor
Several field studies led by me at the Open University of Sri Lanka in collaboration with the University of California (US), University of Manchester (UK) and University of Lund (Sweden) in the recent past reveal how the poor are empowered through microfinance in remote areas in Sri Lanka by providing them greater access to finance with different savings and lending instruments. Group-based system in microfinance has helped many poor people, particularly women, in rural areas to inculcate their savings habits and to obtain cost-effective borrowing to expand their income-generating activities, though still there are various limitations and weaknesses in the sector that need to be addressed by policymakers, according to our findings.
Given the island-wide proliferation of mobile phone systems in recent times, there is greater potential to promote mobile banking technology to enhance financial inclusion in Sri Lanka, as in the case of Kenya.
Lotteries are state-sponsored gambling
I cannot understand why Maliyadde dragged lotteries into his discussion. Claiming credit for his initiative in developing lottery business in Sri Lanka, Maliyadde says, “Today, we have ended up with two main lotteries, National Lottery and Development Lottery (incidentally, I am responsible for promoting the latter).”
These lotteries are nothing but State-sponsored gambling which have promoted betting addiction in the society, particularly among low-income households, causing detrimental effects on their livelihoods.
Ironically, Chandasena Maliyadde, who agitates against economic liberalisation, ended up his article with a quotation from some official in the Federal Reserve Bank of Richmond in the United States, perhaps the most liberalised economy in the world. To save space, it would be sufficient to mention here that the quotation has no relevance to a developing country like Sri Lanka.
(Prof. Sirimevan Colombage is Emeritus Professor in Economics at the Open University of Sri Lanka and former Director of Statistics, Central Bank of Sri Lanka, reachable through email@example.com)