LESSER OF TWO EVILS
The Reserve Bank’s decision last month to hike interest rates is not helping South Africans out of their misery
In 2013, an article in The Washington Post raised the question: what makes people more miserable — inflation or unemployment? It has occupied my mind ever since Reserve Bank governor Lesetja Kganyago’s announcement last month of an increase in interest rates.
Kganyago is often at pains to explain that the primary role of the Bank is to keep inflation low and stable. This, he says, is for the benefit of the poor. But we’re living in times of extreme unemployment, so a supportive environment for investment, the opening of small businesses and consumption are important. This means the rates hike raises the question: which is more painful — high unemployment or high inflation?
In 2013, Dartmouth College professor David G Blanchflower and others attempted to determine levels of misery. In a paper presented at the Federal Reserve Bank of Boston’s annual research conference, they introduced a “misery ratio” to compare the awfulness of unemployment with inflation. For this, they considered surveys of wellbeing across Europe to determine how bad people felt during periods of high unemployment and high inflation.
The outcome was that a “one percentage point increase in the unemployment rate lowered our sense of wellbeing by nearly four times more than a one percentage point rise in inflation”. Put more simply, they said, “unemployment makes people four times as miserable [as inflation]”. Intuitively, this outcome should not be surprising: many of us would much rather have money for which we can buy less than no money at all. Considered this way, we should be more tolerant of inflation if it supports job creation.
But what’s concerning in the Bank’s decision to raise interest rates is that, by its own admission, the threat of inflation is low, even if inflationary risks have risen and “the level of policy accommodation remains high”.
Market economists have begun to predict an upward trend or “normalisation” of interest rates. This will affect economic growth and job creation. As the Bank for International Settlements showed in a paper evaluating the impact of monetary policy on the real sector, an indication of higher future interest rates negatively affects spending and consumption.
Earlier this year, the International Monetary Fund argued that central banks, in taking policy action, “need to explain how their actions may increase aggregate welfare by boosting the employment prospects of the poorest and reducing consumption inequality”.
This is not something that came up when Kganyago spoke. However, we do know he often says we can’t rely on monetary policy to improve aggregate welfare and boost employment, and that we need structural reforms instead.
Feeling the pain
But monetary policy has a role in the success and effectiveness of reforms. In 2015, European Central Bank president Mario Draghi attempted to define the relationship between structural reforms, inflation and monetary policy.
He argued that “short-term costs and benefits of reforms depend critically on how they are implemented. If structural reforms are credible, their positive effects can be felt quickly even in a weakdemand environment.”
He added: “Our accommodative monetary policy [low interest rates to stimulate growth] means that the benefits of reforms will materialise faster, creating the ideal conditions for them to succeed.”
With the normalisation of rates lying ahead, monetary policy may not act in a way that will accentuate the impact of reforms.
Yet, as Kganyago noted in his address: “The July unrest, the pandemic and ongoing energy supply constraints are likely to have lasting effects on investor confidence and job creation, impeding recovery in labour-intensive sectors hardest hit by the lockdowns.”
Under these conditions, should SA really have to suffer the pain of inflation too?
What’s concerning in the Reserve Bank’s decision to raise interest rates is that the threat of inflation is low