The interest rate policy of the Reserve Bank and all other central banks in the world is the greatest single delusion in the total economic science because nothing else can be further from the truth as the claims that monetary policy can control the inflation rate, can protect the exchange rate and can promote economic growth," says Fanie Brink, an independent agricultural economist.
He responded to the announcement by the Reserve Bank today that it has increased it’s repurchase rate by 25 basis points, which means that the prime interest rate of commercial banks will increase from 10% to 10,25%.
Brink says there is absolutely no evidence for these claims, in fact, simple statistical analyses clearly show that interest rate fluctuations cannot explain the changes in the inflation and exchange rates or economic growth.
The Reserve Bank's mandate to perform of its primary function as prescribed by the Reserve Bank Act to stabilise prices in the economy "in the interests of balanced and sustainable economic growth" is impossible because prices are determined by the supply and demand in the economy. It can also have very adverse consequences for the economy because, like the government's interference, it can distort the operation of these market forces.
Price levels in the economy are determined by all the factors that affect the local and international supply and demand of goods and services and not by interest rate changes. It is an absolute myth that consumers reduce their spending when rates are increased because the average total interest costs of household amount to no more than 3% of their total expenditure and increases in interest rates are, therefore, negligible small.
Consumers limit their spending much rather due to sharp increases in prices such as food, fuel or increases in electricity tariffs. An R168 increase per month on a R1 million mortgage if the interest rate rises by 25 basis points or a quarter percentage point does not impress any person who earns R3 million a month according to the commercial banks’ requirements to qualify for such a big mortgage.
One of the biggest problems facing monetary policy is the fact that it does not the take the supply side of the economy into account, which can also have very big impacts on the inflation rate, mainly due to, for example, a severe drought such as the country has experienced in 2016 which caused the maize price to increase from R2000 to R5000 per ton. Or when the Organisation of Petroleum Exporting Countries (OPEC) decides to reduce their crude oil production. All the central banks in the world believe that OPEC will increase its production if interest rates rise and are, therefore, prepared to punish the consumers for price increases for which they are not responsible. Most economists always agree with this move because they firmly believe in this delusion of the central banks. The irony is that interest rate hikes cannot have any effect on, for example, increases in fuel prices and electricity tariffs in South Africa because they are governed by legislation, yet consumers are punished for it.
"Interest rates simply do not play such an important role in the economy as the central banks and most economists want it to be because capital as one of the basic factors of production cannot have such a bigger impact on a business venture and the economy than the other basic factors of production such as land and raw materials, labour and management that are at least as important or even more likely to influence the profitability of businesses. The interest rate of most businesses, according to SA Statistics, amounts to no more than 3% of their total operating costs and therefore has virtually no impact on their profitability.
The primary function of the Reserve Bank according to its abovementioned mandate also differs significantly from the primary function as prescribed by Article 224(a) of the Constitution, namely that the Reserve Bank should "protect the exchange rate in the interest of balanced and sustainable growth."
The claims of the central banks that they can perform these functions are not true or correct because the changes in exchange rates are also affected by all the local and international factors that have an influence on the demand and supply of the Rand against the currencies of countries. The effect of interest rate fluctuations on the exchange rate is therefore also negligible small. The Reserve Bank and most economists also believe in this delusion, despite the fact that they even offer 10 or more different reasons during a month in the media for the changes in the exchange rates.
Economic growth is driven and created in virtually all countries in the world through the profit motive within a capitalist economic system and not through interest rate changes. Profits are created, firstly, by the changes in prices of all inputs used in the economy against the changes in the prices of all the outputs produced and manufactured, as well as delivered as services such as finance, legal and medical services through all the different industries in the primary, secondary and tertiary sectors in the economy. Secondly, through the efficiency with which these inputs can be converted into outputs and which could be improved by the application of the latest technological developments.
Brink says that monetary policy is, in fact, an irrelevant and insignificant policy and the impact on the economy is negligible small and also the reason why some of the best central bankers of the G7-member countries already concluded in May 2008 that "Food price inflation may be one of the most serious problems facing the world, but it is one that monetary policy had little power to tackle,” and "Food price pressure is a global problem, we have to observe and monitor it, but we cannot use monetary policy tools to manage this problem. Other policymakers speaking on the sidelines of the meetings said traditional monetary policy tools — such as interest rates — were not suitable to tackle price inflation.”
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Bothaville
22 November 2018
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