Is lowering interest rates good for our economy?

When we talk of ceiling, it involves setting maximum or minimum interest rates by means of regulation.

And here is the fundamental question of concern: Is reduction of interest rates by legal means helpful to an economy?

It may be hurting as well as good to an economy. The only thing left for the policymakers is a trade-off between the two to make an informed decision. Here are some economic insights about lowering interest rates.

Lowering interest rates is good for an economy that is in recession - a situation where the gross domestic product of a country is way below the so-called full employment level. This is usually characterised by high unemployment.

Lowering interest rates encourages borrowing. Thus investments in a country are expected to rise. The rise in investment directly translates to creation of jobs and eventually results in increase in aggregate demand. In short, a fall in interest rate would lead to economic growth.

If this is the aim of the interest rate regulation, then it is more likely to be achieved. Furthermore, interest regulation helps ensure financial institutions such as banks do not exploit borrowers.

On other hand, interest rate ceiling may not be good for an economy. First, part of the reason why commercial banks would charge high interest rate is due to the high risk of default associated with low-income earners. Setting lower interest rate will act as a disincentive to lenders as well as reduce their profits.

This would mean a decline in supply of credit in the economy. Eventually, there will be a rising demand for credit due to a fall in the cost of borrowing. With this great demand for loans, banks are likely to do what we call credit rationing - setting stringent loan terms and a rigorous screening of clients.

This will not act in favour of the lower-income earner, as most of them are in the informal sector and lack sufficient collateral to secure a loan. It will favour high-income earners.

So lowering the interest rate may not be useful to individuals without sufficient collateral to secure a loan. It is like buying a television set or a refrigerator for a person in the rural area who can't afford power connection. In fact, lowering interest rate is likely to lock out more individuals than when it was high.

Secondly, this is likely to see financial institutions introduce non-interest rate charges such as fees, which in the end results in an increase in total cost of borrowing.

Thirdly, a decline in interest rate would mean an expansionary monetary policy. That is, increasing money supply in the economy.

This will subsequently be followed with price of goods and services increasing in an economy hence inflation. Inflation will always worsen the social welfare of individuals in the economy.

I think if Parliament was interested in making credit facilities available to the lower income earners, then lowering the interest rate and imposing a penalty on violators of the proposed amendments is not sufficient.

MPs should also come up with policies that regulate the requirements by banks to secure a loan. If this is not checked, the intended purpose for interest regulation is still unattainable as most of the lower income earners will be locked out on the basis of inability to meet the security requirements.