Austere monetary policy makes no sense
he developed world is much agitated by very low interest rates. So low that it is hard to imagine them declining further. This is emasculating monetary policy.
These rates reflect a relative abundance of global savings. Hence inflation is expected to remain very low. Interest rates offer compensation for expected inflation. The US bond market offers only an extra 1.56% a year for bearing inflation risks over the next 10 years.
It is deflation generally falling prices that has become a threat to economic stability. When prices are expected to fall and interest rates offer no reward to lenders, cash (hoarded notes and coin) may
Tbe a highly desirable option. If prices are to be lower in six months than today it may make sense for firms and households to postpone spending, including on labour, compounding the slow growth issue.
Unwillingness to demand more stuff is not a normal state of economic affairs. If demand is lacking and resources land, labour and capital are idled for want of demand for goods and income they normally produce, a government and its central bank can stimulate spending, including its own, without real cost to taxpayers or economic trade-offs. More demand means no output or income will be lost; there will be more output if demand catches up with potential supply. A win-win, as they say.
Spending can be encouraged by handing out money. For a government, borrowing for 30 years at very low interest is almost as cheap as printing money. One can expect unorthodox experiments in stimulating demand if developed economies continue to grow very slowly and interest rates and inflation stay very low. Cutting taxes and funding a temporarily enlarged fiscal deficit with money or loans is a better way.
While the developed world struggles with low interest rates and highly subdued inflation and expectations of inflation, emerging markets are very different. Interest rates remain high, with elevated expectations of inflation and exchange rate weakness. Interest rates, after adjusting for realised inflation, remain high, as do inflationprotected interest rates.
The SA financial markets have continued to perform very much in line with other emerging financial markets. Emerging market local currency bond yields remain elevated above 6% a year on average for 10-year bonds.
While average bond yields have edged lower in 2019, RSA bond yields have moved higher. The market in RSA bonds is factoring in more, rather than less, inflation and a still weaker rand-dollar exchange rate.
Unlike in the developed world, cost of capital remains high and discourages such spending and growth. Capital remains expensive for borrowers, and growth rates remain subdued.
More inflation expected with less inflation realised because demand has been so subdued, has been toxic medicine for the economy. As in the developed world, the slack in the SA economy calls for stimulation from lower interest rates. And in contrast to the developed economies there is ample scope for traditional monetary policy, that is cutting interest rates. The inflation expected reflects the dangers of a debt trap, and that the government will at some time print money to escape its consequences. Yet fighting such expectations, which have nothing to do with monetary policy, with austere monetary policy makes no sense. It means more economic slack, less growth, a larger fiscal deficit and enhanced inflationary expectations. Eliminating slack with lower short-term interest rates would do the opposite.
● Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.