"The general assumption that the interest rate policy of the Reserve Bank and all the other central banks in the world can contain inflation, protect the exchange rate and promote economic growth by stabilising prices is the biggest single delusion in total economic science," says Fanie Brink, an independent agricultural economist.

Brink responded to the following statements made by the Minister of Finance, Tito Mboweni, in his Medium-Term Budget Framework Statement (MTBFS), which he submitted to Parliament on Wednesday about the inflation rate and the mandate of the Reserve Bank:

“… any growth plan must be built on two macroeconomic preconditions: a sustainable fiscal position and low and stable inflation”

and the mandate of the Reserve Bank which, according to him, is contained in Section 224(2) of the Constitution as follows:

“The South African Reserve Bank, in pursuit of its primary object, must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters.”

However, it should be pointed out that the above-mentioned mandate is incorrect because the primary objective of the Reserve Bank according to Section 224(1) of the Constitution1) is the "protecting the value of the exchange rate in the interests of balanced and sustainable economic growth" and its original mandate according to the Reserve Bank Act2) is “to achieve and maintain price stability in the interest of balanced and sustainable economic growth," which is still seen and accepted by the Bank as its primary function.

"Monetary policy is an irrelevant and insignificant policy and there is absolutely no evidence for the claims made by all central banks that it can contain the inflation rate, protect the exchange rate or stimulate and create economic growth. "

Price levels are determined in the economy by all factors that affect the supply and demand of goods and services and not by interest rates. (Economy 101, Chapter 1, page 1). The reality is, however, that consumers do not lower their spending as interest rates rise, but due to sharp increases in, for example, fuel and food prices, as well as electricity tariffs that cause inflation. Interest costs only amount to about 3% of the total household expenditure and therefore cannot have a material impact on consumer spending.

The Bank can even less protect the exchange rate because the external value of the Rand is determined by al the many other factors that affect the demand and supply of the currency, such as economic growth, unemployment, current account balance, global market trends on emerging market prospects, political developments and pronouncements, the country's credit status, as well as the influence of all the factors that affect, for example, the US dollar and hence the R/$ exchange rate.

The impact of central banks' interest rate policy on economic growth is, in fact, negligible because growth in most countries in the world is driven by the profit motive within a capitalist economic system, even in countries today such as Russia and China.

The profitability of the different industries in the three sectors of the economy is essentially driven by, firstly, the price changes of all inputs used in the economy and the price changes of all outputs produced, manufactured or delivered as services at the prices that are determined by supply and demand.

Secondly, the efficiency with which the inputs can be converted into outputs during these processes as measured by the number of inputs required to deliver one unit of the output. Therefore, ongoing research on new technological development is so important because its application can increase the efficiency of these processes so that more outputs can be delivered by the same number of inputs or the same number of outputs can be delivered with fewer inputs.

In this regard, interest costs play an insignificant role as it amounts to only about 3% of the total operating costs of most business enterprises.

Simple statistical analyses prove very clearly that the changes in interest rates cannot explain the changes in the inflation and exchange rate, or economic growth. Far too much is expected from the mandate and primary objective of the Reserve Bank and the other central banks in the world.

It is not the role of the state to create economic growth, but rather to create an investment-friendly environment that will be conducive to the creation of economic growth. The producers, manufacturers, service providers and other economic activity on the supply side and consumers on the demand side are in fact the biggest and most important role players in the economy as the creators of economic growth, wealth and prosperity in the world and not the interest rate policy of the central banks.

The central banks try to control the demand in the economy while ignoring major changes on the supply side of the economy, which can, for example, be caused by droughts and restrictions on crude oil production, that can even have a much greater impact on prices. The banks are not at all able to stabilise prices, which in themselves is a total illusion.

It is therefore completely incomprehensible why the central banks and almost all the economists in the world continue to believe that monetary policy plays such an important role in the economy at all and why they keep on punishing the consumers of goods and services for price increases for which they are not responsible.
1) Constitution of the Republic of South Africa (No. 108 of 1996) - Sub Section 224(1).
2) Reserve Bank Act (1989)


October 26, 2018
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