Raising interest rates to curb inflation Ineffective monetary policy impacts economy, trade, and investment

Public sentiment is currently extremely fragile. In reality, growing financial hardship is deepening people’s frustration. In particular, soaring prices of essential commodities have left many distressed and angry. For years, a large share of household income has been spent simply on purchasing rice, lentils, cooking oil and other daily necessities.

The ousted Awami League government failed to keep essential commodity prices within people’s reach. During the Yunus-led administration, prices became even more difficult to control. Under the current BNP-led coalition government as well, the “runaway horse” of inflation continues unchecked.

Despite this, every government has largely followed the same strategy to control inflation and commodity prices.

The Awami League government relied mainly on raising interest rates to curb inflation. The interim administration under Yunus pushed interest rates even higher. The BNP government is continuing along the same path, depending heavily on Bangladesh Bank’s contractionary monetary policy and treating higher interest rates as the primary solution to inflation — despite repeated failures.

According to classical economic theory, raising interest rates reduces the money supply in the market. People tend to spend less and deposit more money in banks to earn higher returns. At the same time, businesses become less interested in borrowing for expansion, investment or luxury spending because of the higher cost of loans. As a result, money circulation in the economy declines.

In theory, inflation should then ease automatically.

But that has not happened. Inflation has not fallen; according to recent data, it has actually increased. Bangladesh Bank, however, remains heavily focused on interest rates, repeatedly raising them in an attempt to control prices. Yet inflation persists, while other sectors of the economy have started to weaken.

British economist and Cambridge University professor Caroline Elvins recently argued in an article published by Project Syndicate that inflation cannot be controlled solely through higher interest rates. Inflation stems from multiple causes, and those causes cannot be addressed with a single policy tool.

Caroline noted that many countries now depend almost entirely on raising interest rates to tackle inflation, but the strategy is proving increasingly ineffective. Bangladesh, like many other countries, is facing runaway inflation as one of its biggest economic challenges. To address it, the central bank has repeatedly increased interest rates using conventional economic measures. However, an analysis of global trends and Bangladesh’s domestic market structure shows that raising interest rates alone cannot control inflation and may, in some cases, worsen the situation.

In her article, Caroline pointed out that one of the main drivers of current inflation is the increase in global fuel prices and disruptions in supply chains. This is highly relevant for Bangladesh. Because the country is heavily dependent on imports, rising global fuel and raw material prices increase domestic production costs. Higher interest rates further raise borrowing costs, ultimately pushing prices even higher. In other words, interest rates may suppress demand, but they cannot effectively address supply-driven inflation.

Caroline Elvins argued that while central banks traditionally raise interest rates to reduce inflation, today’s inflation is largely “cost-push” inflation rather than “demand-pull” inflation. When inflation is driven by higher fuel and raw material costs, raising interest rates becomes an ineffective tool. Bangladesh, however, continues to follow this approach — theoretically logical perhaps, but largely ineffective in practice.

Higher interest rates are increasing borrowing costs, slowing the establishment of new factories and limiting business expansion. According to Elvins, this could push the economy toward “stagflation” — a period marked by stagnant growth, weak investment and rising unemployment alongside high prices.

Another key point raised in Caroline’s article concerns “greedflation”, or excessive profit-making by large corporations. She argued that many companies raise prices far beyond actual production costs simply to maximise profits. Higher interest rates cannot regulate such behaviour.

A considerable portion of Bangladesh’s inflation is also seen as artificial. As highlighted in the article, certain powerful groups and corporations exercise monopolistic influence over pricing. In Bangladesh, syndicates are often blamed for manipulating the markets for essentials such as rice, lentils, sugar and onions. While higher interest rates place pressure on ordinary businesses, these influential syndicates remain largely unaffected. As a result, monetary policy loses effectiveness under such conditions.

The article also describes excessively high interest rates as a “punitive measure”. In Bangladesh, high borrowing costs discourage small and medium enterprises and many entrepreneurs from making new investments. This weakens production and increases the risk of unemployment. When production declines, supply shortages emerge in the market, further driving inflation over time.

Another major factor behind inflation in Bangladesh is the depreciation of the taka. As the currency weakens against the US dollar, the prices of imported goods rise sharply. This issue cannot be resolved simply by raising interest rates. What is needed instead is stability in foreign exchange reserves and stronger export earnings and remittance inflows.

Caroline’s article also stresses that inflation is not merely a technical issue; it is also a political one. If the government raises interest rates while simultaneously financing budget deficits by borrowing from the central bank and printing money, ordinary people receive little benefit from tighter monetary policy. In Bangladesh, coordination between monetary policy and fiscal policy is often weak.

If policymakers continue relying solely on higher interest rates without reassessing the broader situation or exploring alternative solutions, Bangladesh could gradually move toward a recession marked by weak growth and declining investment. In such a scenario, inflation may become even more difficult to control.

A review of Bangladesh’s current economic conditions through the lens of Caroline Elvins’ analysis shows that inflation remains high despite rising interest rates, while investment has clearly suffered. Entrepreneurs are reluctant to borrow at high rates because business expansion and investment are becoming less profitable. As investment declines, job creation slows and incomes weaken.

Since much of the inflation is supply-driven rather than demand-driven, reduced investment also weakens production. Lower production creates supply shortages, which push prices even higher. As a result, inflation persists while weak investment and sluggish business growth further aggravate supply constraints. Meanwhile, certain groups continue to make excessive profits through alleged syndicate practices.

In this context, the government should avoid treating interest rates as the only instrument for controlling inflation. Instead, it should adopt a broader and more balanced strategy. Measures could include making interest rates more affordable and rational, even if inflation rises slightly in the short term, as stronger investment and economic growth could offset the damage.

Other necessary steps include breaking up market syndicates through strict legal action, increasing subsidies for agriculture and industry, encouraging domestic production to reduce import dependence, stabilising the value of the taka by reducing volatility in the dollar market and developing domestic energy resources to lessen reliance on global markets. Authorities could also place greater scrutiny on corporations accused of excessive profiteering and impose windfall taxes on extraordinary profits.

Since inflation in Bangladesh continues to rise despite higher interest rates — while investment slows, growth weakens and the private sector struggles — policymakers urgently need to adopt strategies that can revive the economy. Otherwise, the country risks damaging its economy further by keeping interest rates excessively high while paralysing other sectors in an ineffective fight against inflation. The Ministry of Finance, Bangladesh Bank and all relevant authorities should act without delay.