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The inflation monster is here — what are the consequences of monetary policy?


Professor Daniel Meyer is economic development specialist and policy analyst, School of Public Management, Governance and Public Policy, College of Business and Economics, University of Johannesburg.

On a global scale, inflation has been rising rapidly in both developed and developing countries. This rising inflation rate is mainly a result of Covid-19 and, at the beginning of 2022, the Russian-Ukrainian war. These two events have disrupted the global economy and supply chain systems.

The inflation monster has caused the Governor of the South African Reserve Bank (Sarb) to panic by increasing the repo rate by 0.75% to an upward trending repo rate of 5.5%. This increase is the highest single increase since September 2002, and those increases 20 years ago pushed the country into a recession.

The Sarb has already indicated that we will continue to have low economic growth of 1.3% and 1.4% in 2023 and 2024, respectively. More aggressive interest rate increases are therefore expected in 2022 and 2023, with the next increase coming already in September 2022 of at least 0.5%.

This upwards cycle is only expected to turn in 2024, with inflation only expected to reach the 4.5% mid-point of the Sarb inflation target by then, according to the Sarb.

The Sarb Governor stated in the Monetary Policy Committee (MPC) statement on 21 July 2022 that the bank will do its best to protect household income from inflation. The question could be asked, what impact will this and future interest rate increases have on economic growth, and what will the extent of job losses be? The Governor wants to protect people’s income from rising inflation, but the increase in interest rates could cause a recession with more unemployment.

For the first time in decades, the South African inflation rate is lower than the US (inflation rate 8.6%; repo rate 1.75%) and the UK (inflation rate 9.1%; repo rate 1.25%). Another example is Poland, whose inflation rate has reached 15.6% with a repo rate of 6.5%, as the fastest-growing Western country over the last 20 years.

South Africa has an inflation rate of 7.4% versus a repo rate of 5.5%. Maybe we should think out of the box in the fight against inflation. I am not saying monetary policy should not be used at all, but how will an increase in interest rates reduce rising and extremely high energy costs? Maybe there are other tools to reduce inflation.

On a global scale, inflation has been rising rapidly in both developed and developing countries. This rising inflation rate is mainly a result of Covid-19 and, at the beginning of 2022, the Russian-Ukrainian war.

These two events have disrupted the global economy and supply chain systems. The supply side of economies has been affected negatively, and this has resulted in rapid increases in prices. The world inflation rate was stable at approximately 3.2% from 2017 to the beginning of 2020, before Covid-19. But the rate has increased to 4.7% in 2021 and in mid-2022 to 7.4%. SA is at the global average of inflation.


The global trend is still upwards towards the end of 2022. The worst performing countries regarding the containment of inflation are Lebanon at 211%, Zimbabwe at 192%, Venezuela with 167%, Turkey at 73% and Argentina with 61%. These countries are experiencing hyperinflation, which has dire consequences for any economy. The term is used when the inflation rate increases by more than 50% a month.

Hyperinflation is caused by the rapid rise in the money supply, or in other words, the printing of money by the government. Many countries, including SA, are also experiencing another type of inflation, namely stagflation, where output falls, but the price level rises.

Within the G20 group of countries, the inflation monster is also rearing its ugly head. China still has relatively low inflation levels at 2.1%, but most other G20 countries are showing rapid increases in inflation levels.

The Eurozone and the US have more than 8% inflation, which levels have not been seen in 40 years. South Africa’s inflation has risen above the Sarb upper band. However, South Africa’s inflation rate usually lags behind the leading developed countries and trade partners. We expect inflation to rise over the next few months to above 8% towards the end of 2022. Not because of growing demand but also rising and high energy prices.

Rising energy costs

As stated, the main driver of inflation in SA is the rapid increase in energy costs (fuel and electricity). Since 2010, the South African inflation rate has been contained within the inflation target band between 3% to 6% but, unfortunately, economic growth was generally low or even negative. From June 2021 to date, the petrol price has increased by approximately R10 per litre. Economic modelling indicates that each R1 increase in the fuel price could lead to about a 0.3% to 0.5% increase in inflation. Predictions are that inflation will peak only at the end of 2022.

Depending on oil and electricity prices, inflation will stabilise during 2023 and decline again in 2024 towards the Sarb mid-point target of 4.5%. Therefore, more interest rate increases are expected during 2022 and 2023, peaking at approximately 6.5% and 7.0% (repo rate). These increases will continue to deliver financial pain to consumers who are already under enormous pressure. Consumers’ spending is already low. Any decline in such spending, which makes for two-thirds of aggregate expenditure, will probably push the economy into a recession.

Core inflation concerns

Another vital issue to consider in this debate is the level of core inflation in SA. Core inflation excludes prices of food, beverages and energy. Over the last 12 months, the core inflation rate increased from 3.0% in July 2021 to 3.6% in January 2022 and to the June 2022 rate of 4.4%. The excluded products account for close to 60% of the rise in inflation.

These numbers confirm the cost-push inflation environment in SA. The excluded products drive our inflation rate to a much greater extent than most of our trade partners, including the US, at 5.9%. Core inflation has fallen since March 2022 in this country.

A similar situation is experienced in the UK, with core inflation down to 5.8%. Demand-pull inflation plays a more significant role in these countries compared to SA. Therefore, the use of monetary policy in these countries could make more sense.

Source: World Bank data.



Interest rate differentials are critical to attracting investment and strengthening the currency. Table 2 is a summary of the net repo rate differential between SA and the US. The table clearly shows that the differential has decreased since 2019. Both Central Banks are currently increasing interest rates aggressively. For example, the Sarb increased the repo rate on 21 July 2022 to 5.5% from 4.75%, while the US Central Bank recently raised the interest rate again.

A decreasing differential usually leads to an outflow of capital from the country and puts pressure on the exchange rate. This is the main reason for the Sarb increasing the repo rate. But these increases are expected to have dire impacts on the economy.

Source: SARB data.

The current global inflation crisis is caused by the disruption in the supply side or, in other words, by cost-push inflation. This type of inflation is caused by an increase in prices of inputs such as fuel prices, electricity, labour, raw material, global supply chains, etc. This increase in prices of production factors leads to a decreased supply of these goods.

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In the current situation, the global economy was recovering at the beginning of 2022 with rising demand and improved supply lines. But the Ukraine war has even had a more significant impact on the supply side. It has driven inflation to highs not seen in four decades. We, therefore, have low levels of supply, pushing prices upwards. But the other problem is that low levels of economic growth are usually accompanied by cost-push inflation.

A decrease in supply is the leading cause of cost-push inflation, with rising costs of production leading to a reduction in production volume. Rising prices cause demand for higher wages, leading to higher production costs and further pressure on prices. The counter to cost-push inflation is supply-side policies, which are challenging to implement and usually take a long time to take effect due to their structural change nature. Supply-side policies have the aim to increase aggregate supply in the economy.

Monetary policy, as currently implemented, usually causes even lower economic growth and subsequent job losses. The increase in interest rates will not reduce fuel and electricity prices, the main drivers of price increases across the board in the current economic environment.

Globally, central banks are trying to curb rising inflation, but what could be done to curb cost-push inflation?

Monetary Policy

Central banks usually treat inflation in general terms and do not necessarily distinguish between the various types of inflation. The primary goal of the Sarb is to protect the currency and, therefore, price stability; a secondary goal is to ensure economic growth. The Sarb Governor also indicated that he expects the economy to contract by 1.1% in the second quarter. However, the system is still shocked by a huge interest rate increase!

To curb whatever kind of inflation, the Sarb increases interest rates because this policy move is deflationary. But, using monetary policy in a cost-push inflation environment is like hitting the economy with a sledgehammer. It could stop fast-rising inflation but also severely affects the already low economic growth environment, leading to a possible recession and loss of jobs.

Higher interest rates discourage consumer spending and capital investment so needed for growth. On the other hand, higher interest rates support the currency’s appreciation but make the export of goods more expensive and imported goods more attractive, leading to a possible negative trade balance. The rand has already appreciated more than 1% since the increase on 21 July 2022. This could lead to lower fuel prices but possibly impact exports negatively. In any policy decision, there are consequences and opportunity costs.

Central banks, however, could decide to allow this type of inflation to remain high, expecting the cost-push inflation to be of short-term impact and not permanent because it is driven mainly by energy costs and as a result of the Ukraine war. For example, the high fuel price is expected to be temporary. The Sarb has, however, used monetary policy over the last decade to keep inflation at a low level, even in a cost-push inflation environment. This is one reason why we have been trapped in a low-growth situation since 2017.

Fiscal policy 

The government could pursue deflationary fiscal policy such as higher taxes and lower government spending. This alternative is not an option due to the already high personal income tax scales in South Africa as well as the dampening effect it will have on economic growth and employment.

Supply-side policies

The most suitable solution to curb cost-push inflation is to use policy to increase production by reducing or stabilising production costs and increasing supply. But history informs us that supply-side policies take more effort from the government to implement compared to increasing interest rates and take a long time to take effect, similar to monetary policy. What type of supply-side policies could be implemented by the government?

Firstly, production costs should be contained, and government should allow for incentives for increased production. Rising energy costs currently push up production costs. More flexible energy policies should be in place to keep oil and electricity prices stable even if the trend is upwards. Obviously, a stable electrical supply is also needed with no rolling blackouts.

Secondly, supply chain and transport bottlenecks should be minimised to ensure that all ports work efficiently. Also, ensure road and rail transport routes work well in transporting goods.

Thirdly, wage increases should be minimised at below-inflation rates. In SA, wage pressure is building from institutions such as Eskom and government labour unions.

Fourthly, and importantly, government can reduce red tape, creating a more conducive environment and easier-to-do business and attract investment.

The other additional impacts of rapidly rising interest rates include an increase in the cost of borrowing, reducing consumers’ disposable income and limiting consumer spending. Business owners also cut back on their expansion plans leading to a decrease in capital investment, which is a key driver of economic growth. Rising interest rate differentials lead to an appreciation of the currency due to a net capital inflow. Rising interest rates also lead to an increase in government debt payments.

Any policy takes time to have an impact due to time lags. The impact of increased interest rates will not immediately affect inflation. Still, it could take six to 12 months to have any effect.

The battle against inflation requires an integrated approach that includes data-based decision-making, supply-side and demand-side policy tools, and strong leadership and implementation. It is essential to support the economic base sectors, including agriculture, mining, manufacturing and tourism, for job creation and economic development.

Maybe an inflation mid-point target of 4.5% is too low for a developing country such as SA to allow higher levels of growth so desperately needed. Should we not rather have an economic growth target, rather than an inflation target? DM


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