BoG to cut Policy Rate?

image by wayhomestudio on freepik.com

OPE, what’s going on? Should I be concerned?
Oh no, you shouldn’t be concerned at all. It’s good news! As part of its job description, the Bank of Ghana (BoG) has to make sure that inflation can be controlled. But how does it achieve that? I mean, the BoG employees cannot go around announcing that this is what everyone must price their goods and services. So how can they make sure that prices don’t go out of control? This is where they use the Policy Rate.

What is the Policy Rate?
When you hear the Bank of Ghana talk about Policy Rate, it’s not the principles that govern an organisation ooo. It is rather the interest rate that the Bank of Ghana charges Commercial Banks like Absa, GCB, Ecobank when they borrow money. Yes! The Bank of Ghana gives out loans to commercial banks.

Ah, wait, wait. Banks borrow money? Yes, they do. There are a lot of dimensions to this, but I will focus on one for this piece. You see, businesses sometimes go and borrow money from the bank for their business activities. But the banks sometimes don’t have enough to loan out. They do not want to let their customers go to another bank which has more. So what do we do? They borrow from the Bank of Ghana. But we all know there’s no free money anywhere, so BoG charges interest rate on the loan. This interest is what BoG calls the policy rate.

How Does That Policy Rate Work?
So how does this stop inflation? They’re just doing good business. Well, not exactly. You remember I said the BoG uses this to control inflation? The way it works is that when the BoG charges interest on the loans, the Commercial Banks pass on that interest to whoever they are also loaning money to. So let’s say Josephine owns a provision shop. She is ready to expand it, so she goes for a GHC 10,000 bank loan to buy more goods for the shop.

At the time she is going for the loan, the BoG Policy Rate is 20%. The Commercial Bank gives her the loan at say 25% interest rate. I mean, they also have to make money, hence the 5% addition. So in total, Josephine has to pay back GHC 12,500. Eii, Josephine also has to make a profit from her business, too. Eventually, she also increases the prices of her goods slightly so she can pay the loan and make some profit. See where we are headed?

How Does It Affect Me?
Building from what we just learned, what do you think happens if the BoG were to increase the Policy Rate to 30%? Yes, the bank will give the GHC 10,000 loan out to Josephine, maybe at 35% interest, and Josephine, who now has to pay GHC 13,500, will also increase her prices slightly to make some profit. Then, if the BoG wants to control the rate at which Josephine’s prices are rising (inflation), they just need to reduce their Policy Rate. When they do, the commercial banks will also decrease theirs, and Josephine won’t have to increase prices slightly to make a profit. That means that when you go and buy something from Josephine’s store, you won’t go and see that the price has increased again. The current Policy Rate is 21.5% so news that it might be reduced to 19% is good!