Albert Einstein is rumoured to have said “Insanity is doing the same thing over and over and expecting different results”. Three months ago at an event hosted by Wits School of Governance – the last time the South African Reserve Bank increased interest rates – Governor Lesetja Kganyago asserted “We hear your cries… We do not derive joy from people losing their houses and their cars…”. He further inferred that short-term “pains” are necessary to prevent the “erosion” of our income in the medium term.
Today, the Governor has increased interest rates yet again – pushing our prime interest rates to 10.25%. This interest rate hike is enforced in the attempt to maintain inflation within the 3% – 6% target – in order to (theoretically) maintain price stability in the economy. In lay terms, the intention behind inflation targeting is that the cost of living does not increase beyond the increase in our income over time. But, does it really work?
The reported inflation rates in South Africa, as measured by the Consumer Price Index (CPI), are meant to be indicative of the overall cost of living in the country. The CPI measures the change in the cost of a theoretical basket of goods and services that are typically consumed by the average household. The basket includes items such as food, housing, transportation, and healthcare.
In South Africa, the reported inflation rate has been relatively low and stable in recent years (maintained between 4% and 6%), but at the same time, Stats SA reports that the cost of food in South Africa has increased by an estimated 12.4% between December 2021 and December 2022.
The cost of living continues to increase. Food suppliers in South Africa are warning of local food shortages! The reason is that there are several limitations in food production, distribution and storage that results directly from load-shedding – this is going to drive up food prices. The global commodity and fuel market continues to be inhibited by the war between Russia and the Ukraine – which will have an impact on the global prices of food and fuel. Business in South Africa has been handicapped in their attempts to “Return to Normal” post-pandemic – and as such, household earnings in the country remain constrained.
This is a classic case of mismatched KPIs.
The Reserve Bank, and all their employees, are meeting their targets. But, their defined targets are clearly not resulting in the intended outcomes for all of us.
Inflation targeting continues to be our monetary policy – despite its limitations being well researched and documented:
- Inflation targeting has limited ability to address other economic issues: Inflation targeting is focused solely on achieving a specific inflation rate and may not take into account other important economic factors such as employment, output, or financial stability.
- There is no consensus on what the “optimal” inflation rate should be, and different countries may have different inflation targets based on their specific economic conditions.
- Limited ability to address supply-side shocks: Inflation targeting is primarily focused on managing demand-side pressures on inflation, but it may be less effective in addressing supply-side shocks such as natural disasters, commodity price spikes, or changes in import prices.
- Lags in the monetary policy transmission mechanism: The effects of monetary policy actions such as changes in interest rates may take several months or even years to be fully reflected in the economy, which can make it difficult to achieve the inflation target in a timely manner.
- Difficulty in predicting inflation: Inflation is influenced by a wide range of factors, many of which are difficult to predict, making it challenging for central banks to set an accurate inflation target.
- Potential trade-offs: Tightening monetary policy to curb inflation can lead to higher interest rates and slower economic growth, which can be detrimental to certain groups such as low-income households and small businesses.
- Failure of inflation targeting in extreme conditions: In extreme conditions such as deep recessions or deflationary spirals, inflation targeting may be ineffective and other monetary policy tools such as quantitative easing or negative interest rates may be needed to stabilize the economy.
At the same time, increasing interest rates can have several negative impacts on an economy.
- Reduced economic growth: Higher interest rates can make borrowing money more expensive, which can decrease spending and investment, slowing down economic growth.
- Increased debt burden: Increasing interest rates can make it more expensive for individuals and businesses to service their debt, which can lead to defaults and bankruptcies.
- Reduced housing market: Higher interest rates can make it more expensive to buy a home, which can decrease demand for housing and lead to a slowdown in the housing market.
- Reduced stock market: Higher interest rates can make stocks less attractive to investors, which can lead to a decrease in stock prices and reduced investment in the stock market.
- Reduced consumer spending: Higher interest rates can make it more expensive for consumers to borrow money for things like cars and appliances, which can decrease consumer spending.
- Reduced exports: Higher interest rates can make a country’s currency more attractive to foreign investors, which can strengthen the currency and make exports more expensive, reducing demand for exports.
It is clear that the rethinking of the foundations of our economic-policy decision-making frameworks and responses is past due.
- Does it make any sense to increase the cost of capital, the cost of doing business in South Africa, at the same time that we need to attract significant investment into the Energy Supply Chain in order to deal with our energy crisis?
- Does it make any sense to constrain business expansion when we want to create jobs?
- Does it make any sense to raise the cost of living, when South Africans are already struggling?
These are real problems that we face – and increasing interest rates with the intent of curbing inflation is a theoretical foundation that has proven invalid in our economy time and again.
What does increasing interest rates intend to achieve – price stability.
What does increasing interest rates actually achieve?
- businesses not able to service their debt; being forced into austerity and resultant retrenchments and job losses.
- households not able to service their debt; repossession of assets; blacklisting; removal from economic participation.
- prices continue to increase due to fuel price hikes, increased cost of capital and other factors.
Why do we continue doing the same thing, expecting a different outcome?
Raising the interest rates only brings joy to those with a surplus of money in the bank. As for the rest of us – we are collateral damage – but at least the Governor does not derive any joy from our suffering.
- Kalnisha Singh, founder of KD Strategies
