What you borrow today will be worth less in a year’s time. At the same time, the value of today’s savings will be eroded by inflation over the next 12 months. Unless interest rates restore the balance, there is no reason to save and every incentive to borrow, so what would a reasonable man or woman do?
US economist Joseph Stiglitz suggested recently that Reserve Bank governor Gill Marcus was wrong to hike the bank’s repo rate from 5 percent to 5.5 percent. But, with inflation at 5.8 percent in January, the repo rate is still negative in real terms. And the Reserve Bank expects inflation to head higher, breaching the ceiling of the 3 percent to 6 percent target range.
Inflation targeting has its critics. But it’s hard to see how the absence of targeting would change the reality that negative interest rates won’t encourage saving and could spur borrowing. Already the relationship is badly skewed.
In the third quarter of last year, the ratio of household debt to disposable income was 75.6 percent while the ratio of savings to disposable income was zero. The figures will be updated in the Reserve Bank Quarterly Bulletin due on Wednesday but the ratios are unlikely to have changed much in the fourth quarter.
Why does this imbalance matter? Without local savings, the domestic economy depends on a steady stream of foreign investment into local bonds and shares to keep the economy growing and prevent a further loss of jobs. Already these flows have slowed alarmingly to just over $1 billion (R11bn) last year from $83.8bn in 2012. This year the inflows have reversed: according to figures from Citi, net sales of local bonds and JSE-listed shares in the year to Thursday were worth $22.8bn.
This pattern of behaviour on the part of investors could continue, as interest rates rise in other economies, offering more attractive investment opportunities. A reversal of the US easy money policy has already set the process in motion.
Against this backdrop, surely it’s clear that local savings must be encouraged.
Critics of inflation targeting often argue that unemployment is more problematic than inflation and therefore it would be preferable if the authorities targeted unemployment and ignored inflation. The theory is that, if money is cheap, consumers will spend and businesses will invest, creating jobs in the process.
But in practice this is true only to a point. In a recession, jobs are shed and, as the economy expands, more people are employed – provided business confidence returns. And this is a big proviso. An important ingredient for job creation is business confidence, which depends on more than just the interest rate cycle.
The broad business environment comes into play, with certainty about government policies playing a vital role. Which brings us to the nub of the problem: in South Africa, cyclical unemployment is only the tip of the iceberg.
Unemployment has remained around 25 percent for most of the past 20 years, since the transition to democracy. The problem is structural – that means it is embedded in the structure of the economy. The roots lie in apartheid, with its systematic discrimination against black people and its closed economy, sealed in by sanctions and dominated by large established business interests. These forces simultaneously limited economic growth and kept the poor marginalised.
The 1990s and the new political dispensation brought some solutions: the opening of the economy to the rest of the world and more opportunities for new businesses as the big companies unbundled and invested abroad. And competition laws contributed to levelling the playing fields.
But the 1990s also brought fresh challenges. As the domestic economy evolved in the intervening years to a higher technological level, the barriers to entering the job market rose. And the schooling system failed to respond to the new demands on the workforce. It’s a well documented story that doesn’t need retelling.
An ambitious programme to equip school leavers to work in a modern economy would have done more to increase employment than a monetary policy that ignored upward movements in inflation.
More recently, uncertainty about government policies has placed a further obstacle in the way of job creation by adding to the planning challenges faced by businesses. When offering advice on policy, commentators should understand the domestic context. Copy and paste solutions don’t always work.