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Author: Andiswa Botha|

26 March 2014 11:46

Opinion: Consumers drive prices up, ceteris paribus

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Interest rate forecasts: Managing your expectations could save the economy.

My past lecturer and seasoned journalist, Reg Rumney*, once dedicated an entire seminar to understanding inflation and interest rates. As an economics major in a journalism class I thought I knew a lot when it came to this subject. But that day I understood it in a different way, as a consumer rather than a student.

Speaking from the Africa Media Matrix Rumney told of a retired maths professor in the mid-1980s who was convinced that the Apartheid government was deliberately misleading citizens. The professor had done an experiment and had concrete proof that inflation was much higher than the government reported.

Every month he bought the same basket of goods and used the items to track changes in price. Months turned into years. He had calculated the true inflation rate which, according his basket of goods, was much higher than the official inflation rate.

The professor approached the Star newspaper with his price index, and at first the journalists were taken aback by his discovery and published the findings. Upon further inspection both parties realised that the professor’s calculations were correct but limited.

How inflation is calculated

The Statistical Office was using the Consumer Price Index (CPI) to track the rate of inflation in the mid-1980s. Statistics South Africa (StatsSA) still uses the same index today.

The professor did not know or failed to acknowledge that the CPI is a broad measure of inflation and uses many more items in its basket. StatsSA admits this shortcoming by providing a personal inflation calculator on their site (available here).

The era in which the professor did his inflation calculations is very important in this argument. The inflation rate was relatively high in the 1980s reaching an all-time high of 20.90% in January of 1986.

At that time the reporting of statistics, including the inflation rate, was not as transparent as it is today. Generally citizens did not know how inflation was calculated or the items included in the basket of goods. To put it mildly, the apartheid government had been known to conceal information.

Therefore the perception of citizens that the government was up to no good and understating the inflation rate contributed to the high levels of inflation at that time.

Psychological factors influence how people think about inflation and expectations, and thus behavioural trends are created on this basis.

Behavioural economics is a science underpinned by psychology and microeconomics which studies how market decisions are made based on public choice.

Indeed Robert Shiller’s theory of “irrational exuberance” won him, and two other economists Eugene Fama and Lars Peter Hansen, the Nobel Prize in economics in 2013 for their work in macroeconomics.

“If everyone expects prices to go up, they will go up, because people will buy now to avoid increases later, even to the extent of hoarding items. This is what happens in bouts of hyper-inflation,” said Rumney.

But prediction is not this simple, adds Rumney. Cost push inflation is also a major component of inflation; caused by any products that South Africans cannot manufacture itself but demands highly enough to pay any price for.

Nevertheless, Governor Gill Marcus will announce on Thursday whether the South African Reserve Bank (Sarb) will further hike the repurchasing (repo) rate. The Monetary Policy Committee (MPC) uses the CPI, amongst other economic indicators, to control inflation by changing the repo – the benchmark for other short-term interest rates.

Is an interest rate hike on the cards?

Elna Moolman, Macquarie Securities economist, said that a further 50 basis points (bps or half a percentage point) interest rate hike on Thursday is possible, but is unsure about the pace of the hikes.

In anticipation of the hikes Moolman says consumers could be expected to slow spending, particularly in credit-funded items.

Rumney said the unexpected interest rate hike of 50 bps in January was potentially enough to alter consumer expectations and their optimism about the low-interest rate environment.

“The Reserve Bank has made its point; it is serious about controlling inflation,” he added.

“Predicting is hard even when the bank goes out of its way to be transparent. The problem with the central bank putting up rates to control surges in inflation is that stifles economic activity.”

“If the Sarb has credibility, people will not expect inflation to rise to substantially above the target, and this should limit their wage demands to a degree amongst other driver. But if the Sarb loses credibility, people will generally speaking expect higher inflation, which creates the risk of a price spiral,” said Moolman.

The crux of this argument is that consumers, to some degree, are in control of the economy. Unsecured lending remains a big risk. Managing our credit, not eliminating it, can go a long way towards controlling inflation, and purchasing power, while ensuring growth is not significantly subdued.

*Reg Rumney is the director for the Centre for Economics Journalism in Africa.

** Ceteris paribus means ‘all other things being equal or constant.’

Topics: INFLATION, INTEREST RATES, CPI, MPC, reg RUMNEY, Elna MOOLMAN, CONSUMER EXPECTATIONS, REPO RATE, SARB, gill MARCUS



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