Conventional economic theory suggests that higher interest rates will decrease inflation. It assumes that 1) at higher interest rates, people will buy fewer goods leading to lower demand and hence lower prices, and 2) businesses will invest less, generate less employment and give fewer raises. Thus people will have less money to buy stuff, and prices will decrease.
The theory would hold true if inflation is because of higher demand. In Pakistan’s case, however, higher prices are fueled mainly by the exchange rate depreciation. Since we depend on imports, demand is not causing higher prices but supply.
While higher interest rates are theoretically supposed to attract “hot money” (money that chases the highest interest rates in the world for short-term gains), who would want to invest in a country that Moody rates at Caa3?
A comparison of historical interest and inflation rates in Pakistan does not indicate lower prices after a rate hike. So the Fund’s pressure aside, a lower policy rate will unlikely make onions cheaper.
Published in Dawn, The Business and Finance Weekly, March 6th, 2023
