A public lecture by Lesetja Kganyago,
Governor of the South African Reserve Bank,
at the Nelson Mandela University
Port Elizabeth
1 August 2018
Inequality and monetary policy in South Africa
Introduction
Good afternoon, ladies and gentlemen.
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Debates about inequality have kicked into a higher gear in recent years
in academia, in policy circles, and in the broader political space. For
central banks, especially those in advanced economies, inequality has
become an inescapable issue, and experimental policies like quantitative
easing are being blamed for making it worse.
In South Africa, we have had very high inequality for a very long time, so
for us, these debates are not new. Nonetheless, there are new ways of
thinking and new data to help us understand the issue better.
Today, I would like to make a couple of points to clear up some
misconceptions that people may have about inequality and, more
specifically, about the interactions between inequality and monetary
policy.
First: although everyone knows that inequality within countries has been
rising, inequality between countries has actually been coming down. This
is thanks to sustained growth in emerging markets, which are not as far
behind the rich countries as they used to be.
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Second: in South Africa, inequality has been persistently high but the
composition of inequality has changed. Inequality among black South
so that South Africa's
Africans has increased since the end of apartheid,
inequality story is now about class as much as it is about race.
people often don't know where their family fits in South Africa's
Third:
income distribution, chiefly because people who are relatively better off
often do not realise how much poorer most other South Africans are.
And that helps explain my fourth point, which is that the relationship
between inequality and monetary policy does not work the way people
usually think.
Lower interest rates typically worsen inequality.
I'm going to spend a large portion of my
speech today explaining the four
most important channels through which monetary policy affects inequality
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namely inflation, borrowing costs, asset prices and employment coupled
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with growth to show how this works.
Inequality at the global level
But let me start with the global environment.
Over the past few decades, global inequality has either risen sharply or
begun to moderate, depending on how you look at it. Inequality has risen
in the sense that inequality within countries is often higher than it used to
be. As Thomas Pikkety and others have shown us, for example, inequality
in the United States (US) has been rising since the 1970s, and is now at
levels last seen nearly a hundred years ago, in the 1920s.1 Similar trends
are visible in many other countries.
This increase in inequality has captured many headlines, and has also
been cited as an explanation for political developments like Brexit or the
outcome of the last US presidential election. This rise in inequality is
usually attributed to changes in technology, productivity and the skills of
workers, where the return on higher and newer skills has accelerated
faster than the returns to less-skilled workers.
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However, inequality has also fallen since the 1970s if we look at the
gaps between countries. Fifty years ago, the gap between rich countries
and poor countries was very clear. Nowadays, there are a lot more middle-
income countries. There are also many more rich and middle-class people
in countries that used to be almost universally poor. To take one example:
fifty years ago, even rich people in China were typically worse off than
poor people in the US.
That is no longer true: the rich in China are now rich from a global
perspective, thanks in part to several decades of strong economic growth.
The same thing is now happening in India, which is also catching up with
richer countries because its economy is growing at around 8% a year
(while advanced economies are growing at around 2%).
This decline in worldwide inequality is a big change, reversing a trend of
steadily higher inequality between countries that has held since the
Industrial Revolution.2 The reduction in inequality is driven by some big
trends: better economic policymaking, growth in world trade, the spread
of technology and finance, and more education.
However, the fact that people in poorer countries have been catching up
doesn't mean
with those in richer countries that the world has become
equal. In fact, the world as a whole is probably more unequal than almost
any one country on its own. For instance, while there are now more
middle-class Indians than ever before, the country has also become more
unequal internally.
Estimates suggest that the Gini coefficient of the whole world is around
0.7. To put that in perspective, a relatively equal country like Sweden has
a Gini coefficient a bit below 0.3; the coefficient for the US was around
0.35 in 1950 and is a little over 0.4 today; Brazil is at 0.6. South Africa is
around 0.7, which makes it one of the most unequal countries in the world,
and certainly the most unequal large country.
Inequality in South Africa
South Africans know that theirs is an extremely unequal country.
However, there are some aspects of this inequality which are not well
understood. One is that inequality is no longer as completely determined
by race as it used to be. Historically, of course, inequality in South Africa
was fundamentally a racial story, with access to economic as well as
political rights and opportunities based on skin colour. Since the end of
apartheid, however, this has begun to change.3
Inequality within the African portion of society has risen, as some black
people have moved into the middle and upper classes while others have
stayed very poor. As a result, inequality among black people is higher than
for the other racial categories in South Africa.4 The Gini coefficient among
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Africans is above 0.6 about the same as Botswana, and close to Lesotho
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and Swaziland countries which are less racially diverse than we are but
still very unequal.
Another aspect of inequality that people tend to get wrong is the
contribution of monetary policy. I am often struck by the comment that
higher inflation reduces inequality by benefiting poorer South Africans.
The core of this argument is that higher inflation creates more jobs that go
to poorer people.
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Another part of the argument is that because most households are
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highly indebted, and because poorer households are the most indebted
interest rate cuts will disproportionately improve the welfare of those
people.
I would like to assess those arguments, as well as a couple of other
monetary policy channels that are less discussed, in an effort to get at a
deeper understanding of how monetary policy affects inequality. I will
discuss the four main channels through which monetary policy affects
inequality: borrowing costs, asset prices, employment and growth, and
finally inflation. I will demonstrate that a decision to go for a loose
monetary policy is likely to worsen inequality and make it more extreme.
Interest rates and borrowing costs
What South African households borrow for, and at what rate of interest,
depends mostly on their jobs and income. We can break these
households down, very roughly, into two groups: the top 20% of the
income distribution and the bottom 80%. A team at the University of Cape
Town has built an online Income Comparison Tool which tells you where
your household actually fits in, and which I suggest everyone should try.5
To give away the punchline, however: if your family income exceeds
R173 000 a year, or about R14 400 a month, then you are in the top 20%
of households. Getting into the top 10% of the income distribution requires
just under R270 000 a year, or R22 500 a month.6 The average
government salary is R335 000 a year, which is within the top 10%.7
Compare those income levels to a household in the poorest 10% of South
Africans, which is getting less than R17 721 per year. That is under
That's
R1 500 per month. roughly a tenth of what a family just within the
top 20% is getting.
These income differences play out in the amount of debt households can
take out and the interest rates they pay.
When the Monetary Policy Committee (MPC) moves the repurchase rate
(or repo rate), households immediately see the difference in their
mortgage payments or their car payments. But what does this do for
inequality? The reflex answer is that, in South Africa, there are both rich
and poor people, and the poor borrow from the rich, so higher interest
rates increase inequality while lower rates, or looser policy, reduce it. But
this is misleading.
South Africans in every income bracket tend to have a lot of debt. The
National Credit Regulator reports that there were a bit more than 25 million
'credit active' people in South Africa at the end of last year, which
compares with around 16 million people who have some sort of
employment.
However, South Africans borrow for different things through different parts
of the financial system. Most mortgages for homes, and vehicle loans, are
taken out by that 20% of households earning the most income that we
talked about earlier. Lower down the income ladder, the composition of
debt changes. Mortgages and vehicle loans more or less disappear. In
their place, we see more high-cost debt, like store cards or informal loans.
These kinds of debts carry much higher interest rates. Crucially, these
higher-rate debts are also much less closely tied to monetary policy. When
we move the repo rate, which is the rate at which commercial banks
borrow from the central bank to fund their reserve requirements, the
decision has a direct and strong effect on the prime rate, which is the rate
at which commercial banks lend to their safest customers. This, in turn,
changes the loans that are tied to prime, such as mortgage loans or
vehicle loans. To put numbers on this, we currently have the repo at 6.5%.
The prime rate is at 10%. The average interest rate on a new mortgage is
also 10%, and the average rate on a vehicle loan is almost 12%.
As you can see if we reduce the repo rate by 25 or 50 basis points, people
with mortgages and vehicle loans get a nice saving. But the same repo
rate move has little or no effect on a microloan, which has an interest rate
of roughly 30%, or an informal loan, at an even higher rate. As a result,
there is almost no relationship between the repo rate and the interest rate
on high-cost debt.
Put these two facts together, and we get an interesting implication:
changes in monetary policy have a much stronger impact on the top 20%
of households than they do on the rest of the population. That is not
don't
because poorer households borrow. Rather, it is because they
borrow at interest rates that are shaped by factors other than monetary
policy, including higher costs of offering loans, higher risk of default, and
lack of information about income. When interest rates go down, therefore,
the more highly indebted and wealthier households save much more on
interest costs than the poorer households do borrowing at microloan rates.
This, by itself, worsens inequality.
Interest rates and asset prices
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Now consider asset prices a channel which is often poorly understood.
As with borrowing costs, people tend to think that higher interest rates
reward rich people who have savings. Again, this intuition is misleading.
In fact, much of the global debate about inequality and central banking
rests on the exact opposite claim: that very low interest rates exacerbate
inequality.8 This is because lower interest rates raise asset prices, and an
increase in asset prices benefits those people who already have assets.
We have seen this play out in advanced economies following the global
financial crisis: as central banks cut interest rates as low as possible,
house prices, equity markets and bond prices all soared. The winners
were the people who had already invested in those assets. Those who
lost out were younger people who couldn't afford expensive homes, as
well as savers who had their money in interest-bearing accounts.
As you can see, what really matters for the asset price / inequality channel
is the distribution of wealth. Who has assets? In many advanced
economies, the middle classes tend to have substantial stocks of housing
wealth, even if most stocks and bonds are owned by richer people. This
higher asset prices don't necessarily raise inequality, because
means that
enough people have assets to start with.9
In South Africa, the situation is different: most assets are owned by people
'10%
at the top of the income ladder. As one researcher has commented,
of the population owns more than 90% of all wealth while 80% have no
wealth to speak of; a propertied middle class does not exist'.10 For this
reason, a low interest rate policy that pushes up asset prices will only
magnify inequality. This may also explain why some asset managers are
opposed to interest rate increases and publish angry articles in
newspapers when we decide to raise rates.
Interest rates, employment and growth
In fairness, asset managers aside, most people who argue for lower
interest rates do not really take these effects into consideration. Instead,
they are focused on employment. As they rightly observe, reducing South
Africa's extraordinarily high unemployment rate is crucial to fighting
poverty and moderating inequality.
The problem for us at the central bank, however, is that interest rates are
South Africa's
not the right tool for addressing unemployment problem,
and especially not the joblessness among the poorest households.
In undergraduate economics classes, students are usually taught simple
models in which there is a short-term trade-off between inflation and
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employment the so-called 'Phillips curve'. One explanation of the Phillips
curve relationship is that lower interest rates create more demand, which
in turn creates more jobs but also more inflation, hence the trade-off.
is that higher inflation destroys the value of people's
Another explanation
wages, so they become cheaper to hire and employment rises.11
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The empirical evidence for the Phillips curve, however, is just not there
as researchers have repeatedly reminded us.12 In fact, South Africa tends
to get stronger economic growth and more job creation when inflation is
low, in part because of demand effects but mostly from stronger
productivity growth and investment. It is the wisdom of the inflation-
targeting framework: that we focus on something within our control,
something which is important for balanced and sustainable growth over
the long term.
11
As discussed in Banerjee et al. (2006), Why has unemployment risen in the new South Africa?,
p. 6, available at
https://www.hks.harvard.edu/sites/default/files/centers/cid/files/publications/facultyworking-papers/134.pdf.
12
Fedderke and Liu (2016), 'Inflation in South Africa: an assessment of alternative inflation models',
South African Reserve Bank Working Paper 16/03, available at
http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/7275/WP603.pdf. As
"A core feature of the
these authors observe: South African empirical studies has been a resolute
search for a Phillips curve type of trade-off between prices and demand-side inflationary pressure
associated with real economic activity. A second constant that emerges from the empirical literature
See also Vermeulen
is the consistent failure to successfully support the Phillips curve trade-off."
(2017), 'Inflation and unemployment in South Africa: is the Phillips curve still dead?', Southern African
Business Review, Vol. 21, available at
https://www.ajol.info/index.php/sabr/article/viewFile/154882/144463.
Targeting employment and not inflation could worsen inequality even
more, especially if we were specifically trying to target employment for the
poorest South Africans. This is because poorer households are more
disconnected from labour markets. In fact, as data from Statistics South
Africa tell us, jobs are not even the primary source of income for the
poorest 30% of households in South Africa. Instead, these households
rely heavily on grants. For the poorest 10%, which is around 1.3 million
households, 60.9% of income is from grants and just 13.9% from work.13
People tend to use the term 'working class' to mean poor people, but
the
poorest third of South Africans mostly are not working. Joblessness is
fundamentally a structural problem, explained by factors such as quality
- people aren't
of education, skills shortages and settlement patterns
living near jobs. These are not problems that monetary policy can solve.
If we did have the ability to create jobs generally, that would be a powerful
tool for reducing inequality. But in fact, as a central bank, our ability to
create jobs for anyone is weak in the short run and non-existent in the
long run. If we were in a skills-rich country like the US, with flexible labour
markets, there would be a respectable argument that low interest rates
could help ease inequality by bringing down unemployment caused by a
But that's not the economy we've that's not the
recession.14 got, and
labour market we've got, so this isn't an option for monetary policy
here.
Interest rates and inflation
The final channel I'd like to discuss is inflation.
Inflation is a problem from
an inequality perspective because it tends to hurt poor people more. One
reason for this is that poorer people have less choice over spending. Poor
people's consumption baskets are mostly taken up with a few basic items,
especially staple foodstuffs and shelter. Richer people buy many more
kinds of things, so they have more room to adjust away from items that
get too expensive.15
A second reason why inflation exacerbates inequality is that it is harder
for poorer people to protect their wages and savings against inflation. If
you have a job where you get a cost-of-living increase every year, or if
you have some assets which keep their real value despite inflation, like
Krugerrands or a house, then you can avoid much of the pain of inflation.
But if you are not in a position to negotiate with your boss, or if your
savings are in cash, inflation can hurt you badly.
Given these factors, a monetary policy stance that lowers inflation can
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actually increase the expenditure of the poorest South Africans even as
it reduces the buying power of richer South Africans. The conventional
wisdom about a short-term growth-inflation trade-off therefore needs to be
supplemented with the knowledge that this also poses a growth-inequality
trade-off. Or, to put the point more simply, any decision to tolerate a bit
more inflation for the sake of a little extra growth is also a decision to make
inequality a bit worse.16
Unfortunately, South African inflation has tended to be quite high, and it
has been even higher for the poorest South Africans. Our inflation target
is a range of 3-6% for headline inflation. Since 2010, inflation has been
above 6% for 28 months, just over a quarter of the time. Meanwhile, the
inflation rate for the poorest 10% of households has been above 6% for
51 months, which is about half the time. With an inflation rate of close to
6%, on average, South Africa has become a relatively high-inflation
- almost three quarters of the world's countries have lower
country
inflation rates than we do.
we haven't taken the battle against inflation seriously
This suggests that
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enough. We hope to remedy this by anchoring inflation nearer 4.5% the
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midpoint of our target range as we have repeatedly said in MPC
statements and in speeches. The poorest South Africans should be
among the biggest beneficiaries of that policy.
Inequality and macroeconomic policy
To conclude, monetary policy affects inequality through several channels.
Low interest rates tend to push up asset prices, helping those who have
assets already. Low interest rates also reduce borrowing costs, but mainly
for borrowers at the high end of the income spectrum. Interest rates have
weak and limited effects on employment, especially for the third of
households which are not closely connected to labour markets or which
are disadvantaged by having less education. Where monetary policy
tolerates higher inflation, this tends to reduce spending power, especially
for the poor. Put together, all this suggests that a more inflationary
monetary policy is likely to make inequality worse.
As the guardians of the value of the currency in South Africa, it is important
that we at the South African Reserve Bank bear all this in mind when we
make monetary policy decisions. The richest 20% of South Africans can
make themselves heard quite easily. They let us know when our raising
of rates pushes up their bond repayments. They do a good job of getting
adjustment every year. They often don't realise how many
a cost-of-living
poorer people there are out there, because they assume they are roughly
in the middle of the income distribution, not close to the top. But we as the
central bank have to think about everyone in South Africa, including the
other 80% of households.
I hope that today I have left you with a clearer sense of what monetary
policy does, and what it cannot do. At the simplest level, we know that low
that's what we aim to deliver.
inflation has many benefits, so But there are
South Africa's worst
also many other policies and agencies that affect
problems, including poverty, unemployment and inequality. Our
contribution as the central bank is just one part of the fight against these
evils.
Thank you.