DON'T BLAME THE RESERVE BANK FOR HIGHER INTEREST RATES

The Reserve Bank's monetary policy committee again decided to increase the repo rate this week. This increase will cause even more hardship for a struggling economy. Unemployment will increase, poverty will increase, social tensions will increase, and crime and all other bad things will be the result. And that is exactly what the Reserve Bank wants to achieve. Had the Bank decided not to increase interest rates, the result would have been even higher inflation, which is worse than high interest rates. Of course the Bank does not want us to suffer, but it surely wants to inhibit demand in the economy by making credit more expensive. This is how it works. We all know the demand and supply theory: reduced demand means prices fall, or rise more slowly. If everything works according to plan the inflation rate will eventually fall to within the target band of the Bank, but it is going to be a long and painful process. It is important to understand that inflation is not an event; it is a process. The increase in the price of petrol, for instance, is not inflation. It becomes a process when this initial price shock — petrol price increase in our example — is passed from one economic agent to another. Everybody tries to escape the pain of higher prices by trying to shift it to someone else in the chain of economic events, by increasing their own prices — demands for wage increases, for example. By increasing interest rates, the Bank smothers the demand for credit, making it more difficult for economic agents to pass on the pain. And if it is eventually successful in forcing inflation lower, it will be the weakest economic agent(s) in this economic chain of events that will be forced to absorb the pain when they themselves cannot pass on price increases any more. The “weakest” economic agents are those without the power to “pass on” price increases further down the economic chain of events, usually the poor, unemployed and small businesses. Some are in a stronger position to pass price increases on because of a variety of reasons. They may have skills and can demand higher compensation for their services, but in many cases powerful economic agents are “protected” from this process, not because they have special skills, but for other reasons. Here are some examples of how some are more equal than others: minimum wages protect those with jobs from competition with those without jobs; members of militant labour unions are protected from less militant workers; civil servants (who are mostly overpaid and underworked) are protected by politicians from the competition of non-state workers because they are political allies; state-owned “companies” are often monopolies and are protected from competition; the list goes on. These protected economic agents can and do force their pain on to others. Some are protected by the state (taxpayers) for stupid ideological reasons, some are protected because by keeping them alive they can be fleeced by politicians and other hangers-on. Because some are insulated from the process of lowering inflation, those not protected must take more pain than if we were all treated fairly. But there is more. Because we have a government that is hugely incompetent and often corrupt, its inability and mismanagement have resulted in an uncompetitive macroeconomic environment. A lack of electricity increases costs; collapsing local authorities increase costs; collapsing state-owned companies increases costs; a dysfunctional education system (eventually) leads to unproductive workers who increase costs; political blunders increase costs; high crime increases costs. Should I go on? But there is even more. The fiscal accounts, which the minister of finance is responsible for, have become unsustainable. The fiscal deficit and state debt will be way off the budgeted estimates in this financial year simply because the state spends too much money. And more spending fuels demand in the economy, exactly what the Bank wants to avoid. So, we have the central bank stepping on the brake to get inflation lower while the minister of finance is stepping on the gas with excessive spending. All this happens in an uncompetitive macroeconomic environment created by the ANC government. In the meantime, the government wants higher inflation because inflation erodes the value of money, but inflation also erodes the value of (state) debt. Since the state has too much debt and the government wants to continue to spend more (in nominal terms), the only logical option for the government is to pressurise the Bank to allow inflation to run amok. Expect even more political pressure on the Bank; threats to nationalise it or to change its mandate — all attempts to force the central bank to follow a less restricted monetary policy approach — allow inflation to get out of hand. That means monetary policy and other macroeconomic policies will continue to pull in opposite directions, and there can only be one loser — the economy. Don’t blame the Bank for higher interest rates, blame the ANC government for creating a uncompetitive macroeconomic environment with its incompetence and corruption. Dawie Roodt Chief Economist of the Efficient Group A version of this article was first published in the Sunday Times on 28 May 2023. Alexander Beard RSA (Pty.) Ltd