Key rate: An effective instrument for conducting a regulatory monetary policy?

EL JOUALI Adil,
Professor of economics at Ibn Zohr University.

The Kaldor diagram is described as « magical », because in reality it is impossible to simultaneously achieve the objectives of the major variables of short-term economic policy, in particular, growth, employment, external balance and stability prices. This last variable is strongly affected by the characteristics of the current economic climate, which has experienced real pressure on consumer prices, which in many countries are reaching very high levels. Indeed, this inflation has never recorded such a level for decades.
According to the latest Bank al Maghreb report on monetary policy, inflation came out in August 2022 at 9.1% in the euro zone and 8.3% in the United States, while at the level of main emerging countries, it stood at 15.1% in Russia, 8.7% in Brazil and 7% in India, while in Morocco inflation reached the rate of 7.7%. In this context, central banks are accelerating the tightening of their monetary policies with rapid and significant increases in key rates. Like other central banks, Bank al Maghreb today bases its monetary policy on the instrument of interest rates.
By regularly reviewing its key rate, BAM aims to steer the supply of credit, control the quantity of money in circulation and therefore regulate the country’s economic activity. This choice of modus operandi is in line with the logic of the liberal monetary policy practiced in Morocco since the 1990s, a period during which the financial sphere experienced the beginnings of its reform. However, faced with this current context of « international political tensions, global economic regression, external inflation, consequences of pandemic crises », it is proving very difficult for Morocco to accurately assess the adjustment of interest rates on the real economy.
Aware of the important role played by commercial banks in financing the economy, the monetary policy recently conducted by BAM will certainly have harmful consequences on the purchasing power of middle-class citizens, on investment and on business productivity. Through its orientation tools, BAM intervenes whenever the economic situation requires regulatory policies. Recall that the main role of BAM is to guide the behavior of banking institutions through the readjustment of key rates. However, this instrument could be a double-edged sword. The periodic review of this instrument by the central institution ensures that the money supply is in harmony with the real needs of the economy.
The general rule is simple, either by injecting money in order to improve growth, or by mopping up the money supply circulating in the economy in order to reduce inflation. However, this last measure applied by BAM could have shocks on all the components of money demand. In its report entitled “Assessment of a liberalization imperative carried by the incentive instrument of the key rate”, BAM analysts explain that the rate administered by the central bank can sometimes increase more slowly than inflation. In this case, the real interest rate decreases. The banks will then increase their lending rates because this fall in the real interest rate constitutes deterioration in bank profits and also fuels the demand for credit. It is therefore possible that the speed of adjustment and the quality of transmission are improved in the presence of inflation. Inflation would then allow a better adjustment to the rise of interest rates and, consequently, in certain cases, a better regulation of the demand for credit, underlines BAM in its report. The analysis of readjustment by the policy rate instrument touches all economic problems, thus the effects of switching the policy rate cover all macroeconomic aggregates.
In several theoretical analyses, the effect of the real interest rate on growth, consumption, savings and investment is not without ambiguity. In its report, BAM distinguished three main channels through which changes in interest rates are transmitted to the economy as a whole: 1- substitution effect, measured in terms of cost the opportunity of transferring consumption from today to the future; 2- the income effect, due to the transfer of interest between creditor and debtor agents; 3- the wealth effect induced by the change in the present value of receivables and debts.
Concretely, for companies, the real interest rate is first of all a cost of capital, and as such it enters into the determination of their profits. Thus, the real interest rate affects the discounting of the expected future values of the company’s profits: the higher it is, the lower the present value of the expected future profits. As far as households are concerned, the interest rate determines the income that they derive from the possession of securities or, on the contrary, the weight of their debt. Through this channel, it affects consumption.
The effect of an interest rate increase on consumption will be positive if it translates into an increase in net household wealth and negative if it does not, continues the BAM report. Through scientific logic, BAM tries to interpret, via empirical illustrations, the result of the effects of the increase in the interest rate on the economic sphere. However, the specificities of the current situation could respond to this logic of the central institution? Knowing that the economic future of countries plunges into a climate of uncertainty.