Study finds repo rate should be much lower

The results of a study aiming at influencing the thinking of authorities via demonstrating that there are developmental ways of determining the repo rate, other than just adjusting interest rates for purposes of inflation targeting, were released by the trade union UASA today.

The study, The UASA Optimal Repurchase Rate Estimate using the Rudebush method, was commissioned by UASA to explore alternative ways of realising an optimal repo rate which will address both the unemployment situation and price stability. The study relies on an equation which determines the optimal level of interest rates considering both inflation and unemployment, as developed by Glenn Rudebusch, senior Vice-President of the Federal Reserve Bank of San Francisco, which was adapted to the South African situation.

The research was conducted by the College of Economic and Management Sciences of Unisa’s Bureau of Market Research (BMR). The report was compiled by prof. Carel van Aardt economist from the BMR and Johann van Tonder, economist of Economic Trend South Africa.

The results of the study were startling.  According to this equation, the prime rate should now be 5.2% rather than 9%. According to the researchers the reason for the lower prime rate can be attributed to the following:

o       Firstly, the equation takes unemployment seriously and as such it is not treated as a subordinate target to inflation (as is currently the case). In this instance the expanded unemployment rate is used - as in South Africa’s case it provides a better picture of the employed and unemployed population.

o       Secondly, there is no specific inflation target or target range.

The researchers  stressed that more research on this issue needs to be performed and that further analyses will be conducted with the job creation target of creating 5 million jobs by 2020 as the primary objective combined with different inflation targets.

The study further found that South Africa’s large component of structural inflation cannot be eliminated via higher interest rates. Indeed, higher interest rates only aggravate the country’s already very high unemployment rate.

Furthermore it was found that making unemployment part of the inflation targeting framework might not be a far-fetched proposal, following a fresh wind of change in terms of macro-economic frameworks blowing through the corridors of the International Monetary Fund (IMF), which is instrumental in world economic policy formation and determination.

UASA spokesperson André Venter says the union commissioned the study because it has long been UASA’s view that employing interest rates to manage inflation is ineffective given the South African situation of structural inflation.

“UASA is of the opinion that the current inflation targeting framework employed by the South African Government and the South African Reserve Bank is protectionist in nature. Persistence with this regime intimates that inflation targeting is more important to the South African Government than our unemployment situation, one of the highest in the world today,” said Venter.

Venter cited Olivier Blanchard, chief economist of the IMF, who last week admitted that the credit crisis proved the current macro-economic policy framework to be inadequate to deal with the world’s economic problems. “According to Blanchard, who launched the debate on a new macro-economic policy framework with other influential economists two weeks ago, one target such as inflation targeting and one instrument namely interest rates are not sufficient anymore. He proposed that a multiple of targets with a multiple of instruments be used to address the world’s economic problems.

The report, the first of its kind in South Africa, will initially be updated quarterly to coincide with meetings of the Monetary Policy Committee of the South African Reserve bank.

Study finds repo rate should be much lower at 5,2%