Inflation Targeting & Interest rates – A Conundrum!

We live in interesting and challenging times.?Times where certainty no longer exists. Uncertainty has become the norm.?We have witnessed a major pandemic that has engulfed the planet resulting in a new normal. An increase in conflicts both domestic and between countries. The rapid increase in the price of crude oil has sent the world into a total spin as fuel prices have reached new highs that has placed a question on go back to office versus remote working in the spotlight for many workers. ?And along comes the question of rising inflation…

Turkey' current inflation rate is the highest since 2002 with many analysts linking this to unconventional economic thinking with a stance to lowering interest rates. The question many ask, is this the approach to tackle rising inflation?

We need to understand what inflation is. Inflation is a measure of the rate of rising prices of goods and services in an economy. Generally, when the input costs to manufacture products rise this contributes to the rise in prices of the finished goods which leads to the increase in inflation.

We have heard of this term used by Central Banks of Inflation Targeting. What is Inflation Targeting? Inflation targeting is a monetary policy where the central bank sets a specific inflation rate as its goal. The central bank does this to make you believe prices will continue rising. It spurs the economy by making you buy things now before they cost more.

The inflation target applies to the?core inflation?rate. It?takes out the effect of food and energy prices.?The difficulty is in creating the right economic climate to create rising prices.?That's where inflation targeting comes in. This sounds like a perfect way to control inflation, Right?

Now, take South Africa, where I live. It is seen as an emerging economy. Some of the key challenges South Africans face are…High levels of corruption, think state capture; high levels of crime, high unemployment, a weakening currency, increasing energy costs, increasing fuel costs, rising food costs and the challenges of growing a stagnant economy.

The Central Bank in South Africa, or the SA Reserve Bank (the SARB) does not have an easy task on its hands in its mandate on fiscal policy. Is Inflation Targeting the answer for South Africa? I am no Economist; however, I have studied Economist (as part of my wider academic studies) at both undergraduate and postgraduate level. With my consulting background and involvement in the Academia, the need to throw challenging questions into the hat are not unusual.

Here is my question? I understand the need to increase interest rate to counter rising inflation. In South Africa, South Africans are burdened with many other costs that affect their disposal income. The latest increase in the basic interest by the SARB of 0,75% or 75 basis points has taken the market by surprise. Many have reacted that this increase was a little to aggressive. ?Setting this aside.

My question revolves around the regular interest hikes to stem inflation increases. With an increase in the interest rate by the Central Bank (in this case the SARB), commercial banks raise their lending rates. South Africans are generally poor savers, and many people living on credit (mortgages, car loans, credit cards). With the increase in lending rates, borrowing costs increase. This will have a knock-on effect on businesses that have regular borrowing costs repayments. These operating costs must be recovered somewhere in the business operations as it eats away profits. The logical approach would be to increase prices of goods manufactured and sold. This in turn adds to inflation. There is a further knock-on effect on disposal income in the hands of consumers. Which in turn drives the SARB to push interest rates up again to counter the rising inflation. This cycle I believe is counter productive to a struggling economy. How do you grow an economy when borrowing costs are increasing and disposable income is declining.

With consumers spending less, many sectors of the economy will suffer resulting in job losses as the decrease in consumer spending will certainly have a negative effect on the economy.

The question is “How does an economy like South Africa address the increasing inflation without the aggressive approach to rising interest rates?” No Crystal Ball present….South Africa has many challenges and no easy solution. A young democracy with a need for radical economic and fiscal change is needed. Bringing together the best minds across many spheres of industry experts, will certainly assist. The main challenge would be speed of implementation that is supported by labour, business and government.

These are my two cents of thoughts around this conundrum of inflation targeting and inflation….what are your thoughts???