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ECS3701 ASSIGNMENT 2 2023
- Institution
- University Of South Africa (Unisa)
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0717513144 ECS3701 2023 muzavazi47@gmail.comDISCLAIMER
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Page 1 of 25
,0717513144 ECS3701 2023 muzavazi47@gmail.com
1) (a) As an economist, what advice would you give the South African
Reserve Bank (SARB) regarding the continuous increase in interest
rates? In your answer indicate whether you think the SARB MPC is
doing the right thing. Explain why and what can be done better, if any.
If you believe this move is correct, explain why you think this is so. [10]
• Of course, interest rates is the most common and powerful monetary policy tool
in the hands of monetary authorities.
• The government, through the monetary authority, uses the interest rate to
control economic activities and outcome, towards a desired ending, including
low inflation.
• Therefore, the government can continue using the interest rate for the intended
purpose.
• However, it must consider alternative tools such as open market operations and
reserve requirements.
• This is because interest rate can be directly inflationary as interest is a cost of
borrowing hence negatively affect (discourage) investment and consumption,
consequently, reduce real output and can cause unemployment rise.
• If interest has to be used, an optimal interest rate should be set
• Alesina (1988) notes that interest rate must be used cognisant of the transission
mechanism
• Transmission process is generally complex and involves high degree of
uncertainty in terms of timing and size of impact in the economy.
• Barro (1997) adds that transmission mechanism involves long, variable and
uncertain time lags, making it difficult to predict precise effect of monetary policy
actions on targeted variables such as inflation.
• Alternative policy can be used namely fiscal policy or supply side policies to
increase productivity hence reduce inflation
• Fiscal policy can be used together as a policy mix with interest rate
Page 2 of 25
, 0717513144 ECS3701 2023 muzavazi47@gmail.com
(b) Which monetary policy mandate is the SARB pursuing? Provide in
detail a further illustration of the chosen mandate. [5]
• The SARB is pursuing price stability (stabilisation).
• National Treasury, in consultation with the SARB, sets the inflation target, which
acts as a benchmark against which price stability is measured.
• The SARB then independently makes monetary policy so as to achieve this
target.
• The basic aim of monetary policy is to determine how much money an economy
should have in circulation.
• The monetary policies of countries may differ, but most major economies aim
for low and stable inflation and have publicly announced inflation targets.
• To protect the value of the rand, the SARB uses inflation targeting, which aims
to maintain consumer price inflation between 3% and 6%.
• The value of the currency is therefore protected relative to domestic consumer
prices.
• Monetary policy is implemented by setting a short-term policy rate – the repo
rate. This affects the borrowing costs of the financial sector, which, in turn, affect
the broader economy.
• The repo rate is so called because banks give the SARB an asset, such as a
Government bond, in exchange for cash.
• They can later repurchase (repo) that asset at a lower price, which reflects the
interest they paid (i.e. the repo rate) to have the cash.
• South Africa formally introduced inflation targeting in February 2000.
• This is a framework in which the central bank uses monetary policy tools,
especially the control of short-term interest rates, to keep inflation in line with a
given target. South Africa's inflation target range is 3−6%.
• Before adopting the inflation-targeting framework, the SARB used several
different frameworks, including exchange rate targeting and money supply
targeting.
• The inflation-targeting approach has been more successful. It has permitted a
more realistic alignment between the SARB’s tools and objectives.
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