First Low Inflation, Then Cheap Loans

József Rippl-Rónai: Woman with a Birdcage (1892) // Public domain

The ongoing election campaign has become an opportunity for political parties to present populist solutions to problems that are not always real. One theme are the seemingly high mortgage rates. In reality, however, rates are much lower than the current and projected increase in prices and wages, which means that the burden on debtors would decrease even if they would not pay their instalments and the interest would increase their debt.

In the conditions of expected inflation at the level of dozen or so percent for this year (according to the National Bank of Poland, it will amount to 11.9 percent), the Law and Justice government has presented a bill that would ensure mortgage interest rates at 2 percent for 10 years (taking into account the bank’s margin, it will amount to approx. 4 percent). At the end of February, the government’s proposal was outbid by Donald Tusk, who promised zero interest. The Polish People’s Party (PSL) also presented its “Własny Kąt” [Your Own Corner] program, which promises a loan with an interest rate of 1.5 percent. Politicians, presenting their promises, do not mention that taxpayers will pay for everything, including those who did not take any loans.

Inflation, Interest Rates and Loan Installments

With high nominal interest rates and high inflation, credit is only expensive at the beginning; over time, however, in relation to wages, it becomes cheaper very quickly. High nominal interest rates are responsible for the fact that loan installments are initially high in relation to income, which reduces credit rating (calculated on the basis of interest rates and income at the time of taking out the loan) and discourages to take loans. On the other hand, with high inflation, nominal wages grow rapidly. In this situation, the burden of the loan installment on one’s income decreases significantly each year.

In comparison, with low nominal interest rates and low inflation, credit is cheap at first, but the burden decreases at a slower rate over time. For borrowers, this is of course a much more comfortable situation, because then the credit rating is higher and the installment’s burden on income is more evenly distributed over time. This is helpful for better planning of household budgets.

Politicians promising cheap or even free loans offer a solution that is supposed to mitigate the effects of double-digit inflation for the selected individuals, but they do not fight the inflation’s causes. They suggest painkillers, contributing to the deterioration of the situation in the long term.

Causes of High Inflation in Poland

High inflation in Poland is the result of the government’s populist policy with the support of the central bank, which ensured the possibility of cheap money borrowing by the state. In Poland, even before the outbreak of the Covid-19 pandemic, inflation exceeded 3.5 percent per year (which means it was higher than the upper limit of the target range). Despite this, the Monetary Policy Council did not decide to raise interest rates at that time, leaving the NBP reference rate at 1.5 percent.

After the outbreak of the pandemic, the MPC lowered the NBP reference rate to 0.1 percent in three stages. Due to the drop in prices on global markets, inflation in Poland dropped slightly at the turn of 2020 and 2021 to approx. 2.5 percent. However, throughout this period core inflation (excluding food and energy prices). remained elevated.

Despite many disturbing signals, the NBP’s president announced at press conferences that high and constantly growing inflation is temporary, and possible increases in the reference rate would be a “rookie mistake”. The MPC did not decide to raise the reference rate until October 2021, when inflation reached 6.8 percent.

Low Inflation Instead of Populism

Subsequent increases in interest rates resulted in an increase in the nominal interest rate on loans, which resulted in an abrupt increase in the installments paid by debtors. However, the increase in installments in relation to income is a temporary phenomenon. If inflation is under control, interest rates will be lowered and loan installments will fall; if inflation remains high, households’ nominal income will grow rapidly, and as a result, installments will become less and less of a burden on their budgets over time.

If politicians really want mortgage loans to become more accessible to young people, they should first propose solutions that will help restore price stability. Then it will be possible to lower nominal interest rates, thanks to which loan installments will fall, the loan will be relatively cheap from the beginning instead of becoming so after several years, and the installment burden on income will be relatively stable over time. Giving to the selected a free or preferential credit at the expense of all taxpayers, in the conditions of a double-digit price increase, only keeps us away from this goal.

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