Cost push inflation v demand pull inlation

Was the central bank right to increase interest rates?

The consumer prices nearly doubled in October to 14.3% from 7.7% in September. The Central Bank responded to curb this soaring inflation by increasing interest rates from 12.5% to 15.5%. Despite this being the expected monetary policy to curb inflation, the question, was it the right move?

To understand, we first have to know what has caused this rise in inflation rate. Increasing interest rates is normally a right monetary policy if the inflation is as a result of aggregate demand and output is growing at an unsustainable rate leading to increased pressure on scarce resources and a positive output gap, this is known as Demand pull inflation. Like what’s happening in the United States, the Fed wants to raise interest rates because they believe the current growth rate may lead to high inflation rate beyond the normal projected increase in prices.

In Zambia we are not dealing with this kind of inflation, insted businesses have responded to rising costs by increasing their prices to protect margins. This kind of inflation in economics is what we call cost push inflation. There many reasons which have led to this in Zambia:

– High cost of fuel: Despite the fall of oil on the international market, the govt increased the fuel prices, which lead to high transport costs hence increasing the cost of production. Businesses respond to this by increasing prices.

– Load shedding which has reduced the supply of some goods and services to the demand hence price increase

– A fall in the exchange rate: This can cause cost push inflation because it normally lead to an increase in prices of imported products.

Though the increase in interest rates policy may work to reduce this type of inflation, it’s a wrong move because it may lead Zambia to a recession. The economy of Zambia was projected to grow above 7% but it’s currently around 4.8% which is already bad for a developing nation of which the average was supposed to be around 8%. High interest rates discourage investment; this will lead a further decrease to our growth rate hence lead to high unemployment rate. If the economy is not growing no jobs will be created.

What should have been done?

Cost push inflation is normally a short term economic problem. The government should have responded by lowering fuel prices, after all its already low at the international market. Countries like the UK have a zero inflation rate because of that.

The load shedding problem is also temporal which might be resolved soon if really it’s the water levels causing it.

The central bank shouldn’t have increased the interest rates; instead the govt should have come up with policies which will sort out what has led to this kind of inflation. It’s a short term problem and therefore can be sorted out by other policies other than increase in interest rates. The opportunity cost of sacrificing investment is too high for a country like Zambia which is heading to recession if appropriate measures are not taken.

By: Philip Maimba ( Student of Economics, Mouloud Mammeri Universty-Algeria)

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