“Paul Richards recently expressed shock over Malawi’s bank lending rates, saying they are prohibitive for individual borrowers and investors. He went on to say that the lending rates in Malawi remain among the highest in the world and that investors cannot afford to borrow at such high rates to expand their businesses.” this quotation is from the Nyassa News a Malawite on line web-page.
Mrs.Paul Richards through those line gives us the perfect picture of high lending rate(interest rate) in small and medium countries. In this section of ABC of the Economy we are going to see the effect of bad monetary & fiscal policy on the economic activity. First let see how did the country end-up in such a mess?
Crowding out effect
The country ended up in this situate following a financing of the budget deficit. The government when financing the deficit will borrow money from the public (say, through issuing savings bonds), reducing then the amount of fund avaliable to the private sector.On graph below the shortage of funds is seen on x axis LF*-LF’. As one can see, the interest rate and lending rate goes higher to L’ at this level L’ lets repeat the conclusion of Mrs.Richards “investors cannot afford to borrow at such high rates to expand their businesses
When the Central bank comes in play
in the case of Malawi, the central bank was trying to combat the inflation which was caused by shortage of food (due to bad harvest). In order to do so the central bank increased the nominal interest rate. Mrs Richards said that in Malawi, the Central Bank kept the nominal rate high way after the inflation was brought down in a reasonable range. He concluded that commercial banks should reduce the lending rate to boost the economy. The combine effects of Government borrowing and central bank monetary policy will reduce Investment. On the long term growth could be impeded