Monetary Policy: The Limits to Inflation Targeting the Impact of Interest Rates

Cape Times (South Africa), February 17, 2014 | Go to article overview

Monetary Policy: The Limits to Inflation Targeting the Impact of Interest Rates


BYLINE: Brian Kantor

Is South Africa's monetary policy accommodative? It all depends on whose inflation and whose interest rates you have in mind. We are told by the Reserve Bank that monetary policy in the country is "accommodative" because interest rates are below the rate of inflation. That is because real interest rates are negative. But whose interest rates and whose inflation rates can the Reserve Bank be referring to?

From the perspective of savers, the interest paid on savings accounts in the banks are not keeping up with inflation - and more so if tax has to be paid on interest income. Low real interest rates are tough on savers but, for a good reason, borrowers may be unable to pay any more for the use of their savings. And borrowers who invest in businesses that offer employment need all the encouragement they can get.

From the perspective of business borrowers, especially small firms still able to borrow from banks at prime plus (something over 9 percent), finance may in reality be expensive. The presumption of negative real interest rates is that businesses will be able to increase the prices they charge customers at more than the 9 percent per annum they pay in interest.

If this were the case, simply financing a warehouse of non-perishable goods that increase in value by more than the costs of finance (after taxes) becomes a no-brainer of a profitable business decision. This would presumably make monetary policy accommodative and encourage business to borrow and invest more.

But is this the case for many businesses serving the domestic market? Do they have the power to price their goods or services ahead of the rate of inflation, which was 5.4 percent in December last year?

The weakened state of demand for goods and services may prevent this, as the more detailed inflation statistics bear out.

The headline consumer price index is the weighted average of the prices of goods and services consumed by the mythical average household, some of which have risen by more than the average and others by less.

It is administered prices, those charged by municipalities for water and electricity etc and those subject to additional excise duties, for example alcoholic beverages (up 7.2 percent on average, with beer up 9.2 percent on December a year before), that have been making the inflation running. Administered prices were up nearly 8 percent on a year before in December 2013.

By contrast, the price of clothing and footwear is estimated to have increased by 3. …

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