I wanted to wait until everyone stopped foaming at the mouth like Cujo, talking bout a tie is a win or a tie is a loss, to publish this post. I mean everyone knows Trinidad both won and lost against Sweden 0-0 at the 2006 World Cup. Which means that all the other parties also won on Monday by tying for 0 seats. Anyway, let’s get down to business.
I’m sure you’ve seen the headline in the newspapers or on local TV “Central Bank does X, Y or Z with the Repo Rate” and wondered what’s that about? You’ve probably also wondered what in the H-E-double-hockey-sticks does the CBTT even do other than print money and throw a Carnival all-inclusive fete, which I believe they’ve stopped, so really what is their purpose? Well, one of the main functions of the Central Bank (“CB”) is the creation of “appropriate conditions to achieve the economic objectives of the country”. The decisions and actions to achieve this is known as Monetary Policy.
Monetary Policy is one of the sexiest topics for Economists (yeah they’re not exactly a wild bunch). It’s like the Idris Elba or Jennifer Lopez of Economics. Previously I would have said Ali Khan but recent events have reduced some of the swag there. Let me stop eh before I’m the subject of a video or a stern note or a summons to a PTA meeting. #freealikhan
Before we go any further let’s make sure we’re on the same copybook page. Interest is the price of money. Basic econ rule: when supply is higher than demand, price falls. When demand is higher than supply, price rises.
So how does the CB influence the economy? Well if you think they use some kind of magic conjured up by a buck in the middle of the rainforest, you’re not too far off. The CB utilises a special brand of obeah to influence the supply of money which in turn impacts the economy.
Here’s how it works.
Basically the CB is the ultimate “maco”. It lives in a corner house literally and figuratively. They’re always monitoring economic conditions but specifically interest rates and liquidity (availability of credit) in the banking system. When it wants to “play up in its fadda head” to influence the direction of economy it utilizes two main tools, Open Market Operations (“OMO”) and the “Repo Rate”.
OMO involves the buying and selling of government securities to the commercial banks (“banks”). The purpose is to influence the amount of money available to lend and hence the level of interest rates. For instance, if there is too much liquidity in the banking system, interest rates would be low discouraging saving and making it cheaper to borrow money. The availability of too much credit, easy money if you will, could cause inflation (too much money chasing too few goods, you’d understand this more fully if I posted my inflation write-up before this one…sorry).
Anyway, in that situation the CB would sell securities to the banks to take away some of that liquidity and lock it away in what they call “sterilized accounts” so it doesn’t make its way back into the banking system. This should have the effect of increasing interest rates, encourage saving thus curbing inflationary pressures.
On the flip side of the shilling, let’s say there is too little liquidity in the system, the price of money (interest rates) will increase making the cost of borrowing go up thus slowing down the economy. So the ever caring, nurturing and magnanimous CB will buy government securities from the banks which increases the amount of money banks have available to lend which should push interest rates down and help increase economic activity.
As you can see, keeping the economy in between growth and inflation is a delicate balancing act, not unlike buying food for four people at El Pecos and one of them want the callaloo in a separate bowl.
The other powerful tool in their arsenal, not to be confused with Arsenal the football club which isn’t powerful at all, is the “repo rate”. At the end of business each day, banks are required to have a certain portion of their liabilities as a reserve at the CB. Banks with excess reserves are able to lend funds overnight to other banks who are short on reserves in what’s creatively called the “Inter-Bank” market.
When excess funds aren’t available, banks can borrow funds on an overnight basis from the CB in what’s called a repurchase transaction or repo. Basically, the bank that needs funds can sell government securities to the CB with the agreement to repurchase them at a higher price. The rate the CB charges for these transactions is called…surprise surprise…the “repo rate” (ahhh the light dawns!…makes sense don’t it?)
Changes in the repo rate are used to signal to the banking system the direction in which the CB wants short-term interest rates and ultimately long-term interest rates (read this as mortgages) to go, sort of like in the cartoon when Mandrake the Magician “gestures hypnotically” and everyone does his bidding.
Although banks usually follows Mandrake’s gesture swiftly when the repo rate goes up, they are typically a little bit sluggish when the repo rate comes down, probably “ethnic fatigue” from too much dumpling and ground provision at lunch.
So, the next time the CB releases its quarterly Monetary Policy Announcement (scheduled for December 27th), you’ll know exactly what Mandrake, Flash Gordon, The Phantom, Lothar and the rest of the Defenders of the Earth are signalling about interest rates and the economy to the banks but also to us the general public.
PS: The Defenders of the Earth were opposing Ming the Merciless in the future…set in the year 2015!! Yeah…we old like the road.