Aug-Sept 2014 K.indd

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AUG/SEPT 2014 • www.cosatu.org.za

What are interest rates? How do they in fl uence the economy? By Jonas Mosia

T he South African Reserve Bank (SARB) increased the repur chase rate (repo rate) twice be tween January 2014 and July 2014. Since the 2008 global fi nancial cri sis, the SARB had been cutting the repo rate. In March 2009 the repo rate was at 9.5% and reached 6.5% in March 2010, a 31% reduction from March 2009. The repo rate reached its lowest level of 5% in 2012 and remained at that until Janu ary 2014 when the SARB increased it by 0.5% to a new level of 5.5% per annum. It was increased again by 0.25% in July 2014. Thus the current repo rate is at 5.75% per annum. The SARB manages the monetary policy which is based on in fl ation target ing. If there are signs that the in fl ation rate would increase beyond the target range of 3-6%, the SARB increases the repo rate. We will come back to show how an increase in the repo rate af fects the economy shortly. For now we want to explain what this repo rate is all about. The repo rate is the rate the SARB charges the commercial banks when it lends them money. The SARB serves as the lender of last resort to the commer cial banks. The commercial banks go to the SARB to lend money when they experience shortfall in funds. When the SARB increases the repo rate, the com mercial banks (FNB, Stand Bank, ABSA, ABSA, Capitec, etc) also increase the interest rate at which the commercial banks lend money to the public. The dif

less attractive than deposits denominat ed in foreign currency; causing depre ciation in the value of the rand. This will be so if foreign interest rates remain un changed. With the value of the rand de preciated, imports become more expen sive than locally manufactured goods. The exports become cheaper and thus export oriented industries produce more goods for international markets. However, as the economy would still need imported inputs like oil, the de preciation of the rand also results in an increase in the cost of production and thus increases in in fl ation. The credit channel When the repo rate increases, the market interest rates increase. The bank deposits will increase as the banking public hopes to get better returns when interest rates are high. The interest rate is actually the price of money. High inter est rates means the price of loans would be high, borrowers would pay more for the loans taken. Accordingly, the issu ing of loans by the banks will decrease. Investment and consumption spending will also decrease. The overall demand for goods and services will also de crease. In conclusion, it is clear that the man agement of the monetary policy needs a lot of balancing act informed by what the country want to achieve. In future editions of this publication we will pres ent the position of COSATU on mone tary policy. So, watch the space.

ference between the repo rate and the bank lending rate or interest rate is usu ally 3.5%. This is the average mark-up the commercial banks add to the repo rate to determine the prime lending rate. Now how does the change in repo rate by the SARB affect the economy as a whole? It does so through various chan nels: interest rate channel, the credit channel, the exchange rate channel and the asset price channel. For the purpos es of this article, we will discuss the fi rst three channels. When the SARB raises the repo rate, the interest rates increase in the fi nan cial market. Commercial banks react to the changes in the report rate by ad justing their lending rates by the same amount announced by the SARB. As stated above, the SARB increased the repo rate by 0.25% in July 2014 and the commercial banks increased the prime lending rate by 0.25% from 9% per an num to 9.25% per annum. When the interest rate increases, fi rms and individuals also respond by chang ing their investment and consumption spending patterns respectively. Ulti mately, consumer spending and fi rms’ investment in, for instance new plants and buying of new machinery, decrease and thus also output in the economy. The reduction in interest rate makes deposits denominated in rand become The interest rate and exchange rate channels

ECONOMY