Raising interest rates to lower inflation works

If I had a dollar every time someone asked why Nigeria’s Central Bank keeps raising interest rates to fight inflation, I’d be on a yacht in the Maldives and not write a weekly column. The CBN has raised interest rates four times this year, yet inflation remains at its highest level in nearly three decades: 34.2%. 

The myth: Raising interest rates to fight inflation doesn’t work.

The facts: Raising interest rates is a monetary tool to manage inflation. Generally, the way it works is that the central bank raises the interest rates  for loans. Banks, in turn, raise the price you pay to borrow money from them. The theory is that when borrowing becomes more expensive, it discourages spending and reduces demand for goods and services. Prices will eventually fall. 

“If raising interest rates to moderate inflation really works, then why does Nigeria’s inflation rate keep accelerating?”

Raising interest rates isn’t a magic wand that makes inflation disappear overnight. When the Bank of England (BoE) started raising rates in December 2021, inflation was 5.4% and rose to 11.1% in October 2022 despite sustained hikes in interest rates. Between December 2021 and August 2023, the BoE raised interest rates fourteen consecutive times to a 16-year-high of 5.25%. It held rates until July 2024. The country’s inflation is now 2%.

On Thursday, August 1, BoE cut the rate to 5%—for the first time in four years. Yet Governor Andrew Bailey told BBC the mission wasn’t “accomplished yet.”

Fighting inflation is not a two-day task, and the rates will not always translate quickly. The current CBN leadership started its inflation fight in February 2024. There’s no fixed timeline for how long the transmission mechanism takes but Bank of Canada estimates between 12 and 18 months. The Bank of England says 12 months to two years. No surprises there, as it kept rates up for two years. CBN governor Olayemi Cardoso expects Nigeria’s inflation to moderate to 21.4% this year. 

Ultimately, one thing is clear: raising interest rates to lower inflation works.