Finance Extremes

[Dolby]

So I last studied economics 20 years back and haven't used it since, so I effectively know nothing anymore .

I do remember, though, that everything is linked - and easier for me to understand the links when I see extremes.

So what would happen/affects be/economic changes if overnight :

1) Inflation jumped to 15%?
2) Interest rate dropped to 0%?
3) R/$ dropped to R5.00

 

[Hamster]

Inflation
Inflation takes away a person's spending ability and effectively makes your currency worth less.

Imports become more expensive and people spend more money on essentials and less on luxuries (less eating out, no more DSTV etc).

That leads to job losses which in turn leads to protests and "anarchy". Those people also become dependent on the state welfare programs and grants.

Now government has an even bigger financial burden and the easiest "sane" way to get more is to raise taxes...which means people have less money to spend (see above).

Government has a real problem: not only is the country's economy tanking but so too are their election hopes. They simply need more money: so let's print some more!

Now your currency is effectively worthless. What investors remained start cutting their losses (less money), imports cost more (less money, less food) and inflation rises some more.

You are now properly screwed.

 

[Hamster]

Low interest rate

People have more money to spend, the economy grows and because supply cannot keep up with demand prices start increasing: inflation

SARB increases the interest rate to combat inflation: spend less, save more, prices drop...

 

[Hamster]

^ all courtesy of armchair economics

Don't know about the exchange rate though. My economics teacher used to say (but this is over 15 years ago) that the perfect balance for imports/exports would be R8 to $1.

I can only imagine that in a country like ours an R5/$1 exchange rate would make imports cheap, people will buy a lot more offshore produced products and shun locally produced but more expensive products. Exports will take a huge hit as well.

That leads to job losses, less people participating in the economy which means less tax income, more financial burden, higher taxes and... inflation. And then as the money becomes worth less the exchange rate rises.

 

[Hamster]

I would love for a real economist to come correct me though.

 

[Speedster]

Is your question what would happen if all three occur simultaneously, or 3 seperate scenarios?

If the first, that is virtually impossible. Interest rates are determined by the Reserve Bank through their repurchase (repo) mechanism and are based on managing expected inflation (there is an approx 18 month lag between interest rate adjustments and effects on inflation). An increase in inflation would trigger an increase in interest rates, so that the (1) and (2) are basically mutually exclusive.

If three separate scenarios then, in very brief (because it's Saturday morning)

1. Interest rates would increase significantly (rough estimate of 19-20% to maintain a real interest rate of around 4%). Increased interest rates would dampen economic activity as less people would be willing to borrow funds for entrepreneurial and direct investment purposes. The rand would weaken drastically, putting further upward pressure on prices (we have a large number of imports) together with a host of other effects of a weakened exchange rate. Also, the media would attempt to stimulate panic and apocalyptic scenarios, although 15% isn't crisis inflation by any means.
2. This would only happen if, such as in Eurozone, US or Japan, inflation is virtually zero (or negative as in Japan for many years). There would be tremendous price stability and many people would borrow funds (as it is free to do so) for a variety of purposes stimulating economic activity, i.e. economic growth would increase significantly. Note that this uptick in economic activity would put upward pressure on prices, which would threaten the 0% interest.
3. Imports (including fuel) would become 2/3 cheaper (in theory anyway - most likely retailers would keep some of the fat so that prices would only fall by, say, 50%). The big negative here is that exports would now become significantly more expensive (in international terms) so that our products would no longer be competitive in international markets. This would require local producers / manufacturers to drop their prices if they wish to continue exporting, and could lead to closure / downscaling of local industry.

There we go - very short overview of what the theory says.

 

[rietrot]

Pretty much what has already been said.

Inflation is measurement of how much prices of goods has gone up, or basically how much your spending power has decreased. If you see inflation of 15% it means stuff has gone up.(officially the basket of stuff that SA stats measures.) which is somewhat suppose to represent the average person, but people argue it doesn't.

What would happen. People would struggle to maintain their lifestyle and afford stuff.(if the economy isn't doing great and everyone didn't get a 20% pay increase)The reserve bank would start pushing up interest rates to fight the inflation by making money more valuable/expensive.

Inflation normally goes up in good times when the economy is growing and people have money to spend. What we are seeing today is inflation because of high input cost (like feul going up) even though the economy is shît.

Interest rates is already explained I think.

The exchange rate is interesting here. It is also a function of supply and demand. If foreigners want to invest in SA, buy shares on the JSE, buy our governments bonds they need to buy Rands. So more demand for the Rand the more valuable the Rand becomes.
A cheap currency is beneficial for exports amd attracting tourist and bad for imports. The opposite for a strong currency. So that's how it remains in balance.

Now our crimeand politics messes with this, because we should get tourist visiting table mountain, converting their euros to Rands and spending their money here. But because of crime they are scared to come.

 

[Speedster]

Pretty much what has already been said.

Inflation is measurement of how much prices of goods has gone up, or basically how much your spending power has decreased. If you see inflation of 15% it means stuff has gone up.(officially the basket of stuff that SA stats measures.) which is somewhat suppose to represent the average person, but people argue it doesn't.

I think the challenge for Stats SA here is "What is an average South African?". They work on a statistically average person, but that person doesn't exist in real life, so that the exact basket (and accompanying figure) isn't really accurate for anyone, although it is representative of the whole. They do also publish inflation stats for different income bands, as well as rural and urban, if you're looking for a number that reflects your scenario more accurately.

 

[gaboom]

1) Inflation jumped to 15%?
Prices of products would increase. SARB targets inflation around 6 percent so interest rates would increase to 'control' inflation.
2) Interest rate dropped to 0%?
Spending is incentived as savings are essentially not (you don't earn money by keeping your money for a rainy day). I reckon obfuscation would increase as a result...
3) R/$ dropped to R5.00
Exporters would not get s much local currency for their goods and not be encouraged to export = potential job losses. Imports would be incentived =cheaper to bring in foreign goods.