Now that the banks have increased their prime lending rate from 10,5% to 11%, it is important to take stock of the Reserve Bank governor’s suggestion, in his presentation to Parliament last week, that there may be a need for further interest-rate hikes.
The question must be asked: What are the costs and benefits of maintaining the country’s real high interest-rate regime — and what are the implications for economic growth?
The fact is that since 2002 lower interest rates have stimulated productive investment.
Professor Epstein of the University of Massachusetts Amherst has recently concluded some work on the impact of lowering interest rates on gross domestic product (GDP), exchange rates and inflation. In Epstein’s model, if interest rates are lowered from 11% to 10%, and kept there for the next five years, it will raise GDP by 0,15% a year. If the government’s R392-billion fixed investment programme is included, South Africa could grow by at least 4,7% over the next five years, and deal a huge blow to unemployment and poverty.
The same one-percentage-point decline in the prime lending rate would lead to a moderate increase in inflation (0,2%) and an average 0,6 percentage-point depreciation in the dollar value of the rand over the five years.
The consequences of interest-rate hikes and their effect on growth, employment and exchange rates are complex, no matter how boldly the governor threatens. We know that higher interest rates lead to lower inflation, but the consequences are not so beneficial for growth, employment and poverty alleviation.
For the Reserve Bank governor and the monetary policy committee, it is a relatively easy decision to make: increase interest rates and control inflation. But for policymakers there are other choices to be made.
We need to ask ourselves what type of society we would like to live in. Our president speaks of ”hope”, but the Reserve Bank governor shouts that we have been ”warned”.
Perhaps the monetary policy committee and governor would like to be lauded by their peers and known as among the most successful implementers of inflation targeting in the developing world. But for many other South Africans our society will be measured by how we are transforming this economy, promoting black economic participation, reducing inequality, creating employment and ending poverty.
A serious rethink of economic policy is called for, including coordinating fiscal and monetary policy, and support for labour-intensive, export-oriented sectors.
For a decisive blow against poverty and unemployment, let us drop interest rates in August.
Lumkile Mondi is chief economist at the Industrial Development Corporation