South African Inflation
Let us talk inflation!
Conventional wisdom in South Africa has been to control inflation via interest rates. Inflation has been set in a band of 3-6% and growth in the country is targeted at 6%.
Worked well for a period of time and interest rates were allowed to drop to promote growth in the country. As we all know, growth is good and allows for more jobs to be created and generally attracts investment. Investment is good for financing our balance of payments.
Then the good old US of A had a problem with weird financial instruments which, given the fact that we live in a world economy, affected banks all over the place leading to a loss of billions of USD given the write downs “required” by the banks. Those write downs are in my mind a very moot point as what the guys are saying is that the property that forms the final underlying instrument is worth nothing on the open market. Economics or pure manipulation of financial figures?
Oil Prices went through the roof and commodities followed suit. Maize prices are up, wheat prices have hit an all time high and so it continues. Fuel prices are raised monthly and generally the COST of goods have gone up substantially year on year.
Let us not talk about Eskom and their price hikes!
The reaction from the Reserve Bank is to increase interest rates to make it less attractive for people to spend money.
What this fails to recognize however is that if the COST of goods have gone up SUBSTANTIALLY year on year, the price will increase independent of demand. That is good old fashion economics 101 as one always has to recover their costs in order to stay in business. As interest forms a cost – be it a cost of borrowing or the returns from placing money in the bank – all that raising interest rates does in a time of cost pressure is increase the cost pressure. Ergo a spiraling effect.
So in effect increasing interest rates reduce discretionary expenditure, which reduces demand for non essential products. Witness the car industry shutting down production due to reduction in demand. As we all learnt in Economics 101, production has an economy of scale formula and the less you produce, the more the item costs to produce. Again Inflationary!
Net effect, companies will drive to reduce costs which will come at the price of reduced jobs and reduced growth in the economy.
Witness the rest of the world reacting to the crises by decreasing interest rates to ensure that their economy does not move into recession. Witness our lads increase interest rates in a vain attempt to keep inflation under control. When inflation is not driven by demand, interest rates are not going help reduce it. Maybe our reserve bank needs to take heed of that.
But then again – maybe not
Conventional wisdom in South Africa has been to control inflation via interest rates. Inflation has been set in a band of 3-6% and growth in the country is targeted at 6%.
Worked well for a period of time and interest rates were allowed to drop to promote growth in the country. As we all know, growth is good and allows for more jobs to be created and generally attracts investment. Investment is good for financing our balance of payments.
Then the good old US of A had a problem with weird financial instruments which, given the fact that we live in a world economy, affected banks all over the place leading to a loss of billions of USD given the write downs “required” by the banks. Those write downs are in my mind a very moot point as what the guys are saying is that the property that forms the final underlying instrument is worth nothing on the open market. Economics or pure manipulation of financial figures?
Oil Prices went through the roof and commodities followed suit. Maize prices are up, wheat prices have hit an all time high and so it continues. Fuel prices are raised monthly and generally the COST of goods have gone up substantially year on year.
Let us not talk about Eskom and their price hikes!
The reaction from the Reserve Bank is to increase interest rates to make it less attractive for people to spend money.
What this fails to recognize however is that if the COST of goods have gone up SUBSTANTIALLY year on year, the price will increase independent of demand. That is good old fashion economics 101 as one always has to recover their costs in order to stay in business. As interest forms a cost – be it a cost of borrowing or the returns from placing money in the bank – all that raising interest rates does in a time of cost pressure is increase the cost pressure. Ergo a spiraling effect.
So in effect increasing interest rates reduce discretionary expenditure, which reduces demand for non essential products. Witness the car industry shutting down production due to reduction in demand. As we all learnt in Economics 101, production has an economy of scale formula and the less you produce, the more the item costs to produce. Again Inflationary!
Net effect, companies will drive to reduce costs which will come at the price of reduced jobs and reduced growth in the economy.
Witness the rest of the world reacting to the crises by decreasing interest rates to ensure that their economy does not move into recession. Witness our lads increase interest rates in a vain attempt to keep inflation under control. When inflation is not driven by demand, interest rates are not going help reduce it. Maybe our reserve bank needs to take heed of that.
But then again – maybe not
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