Inequality, Output-Inflation Trade-Off and Economic Policy Uncertainty

Evidence From South Africa

Eliphas Ndou, Thabo Mokoena

• Publisher: Palgrave Macmillan
• Year: 2019
• Print ISBN: 9783030198022
• eBook ISBN: 9783030198039
• Topic: Business
• Subtopic: Finance
• Index: Business

This book focuses on income inequality, output-inflation trade-off and economic policy uncertainty in South Africa. Tight monetary and macroprudential policies raise income inequality. Income inequality transmits monetary policy and macroprudential policy shocks to real economic activity. Economic policy uncertainty influences the dynamics in the lending rate margins, inflation expectations, credit, pass-through of the repo rate to bank lending rates and companies' cash holdings. The trade-off between output and inflation and output growth persistence vary with inflation regimes. Stimulatory demand policy shocks are less effective in high inflation regime. High income inequality raises consumption inequality, which raises demand for credit, but price stability matters in this link. Increased bank concentration raises income inequality, lowers economic growth and employment rate. Elevated economic policy uncertainty lowers output growth, lowers capital formation, reduces credit and raises companies' cash holdings. Increased companies' cash holdings reduce capital formation and impact the transmission of expansionary monetary policy shocks to real economic activity. This book shows there is an inflation level within the target band below it which lowers income inequality, while raising GDP growth and employment. Thus price stability, economic policy uncertainty and income inequality matter for the efficient transmission of policy shocks.

© The Author(s) 2019

E. Ndou, T. MokoenaInequality, Output-Inflation Trade-Off and Economic Policy Uncertainty https://doi.org/10.1007/978-3-030-19803-9_1

Begin Abstract

1. Introduction

Eliphas Ndou^{1, 3, 4} and Thabo Mokoena²

(1)

Economic Research Department, South African Reserve Bank, Pretoria, South Africa

(2)

Department of Economic, Small Business Development, Tourism and Environmental Affairs, Free State Provincial Government, Bloemfontein, Free State, South Africa

(3)

School of Economic and Business Sciences, University of the Witwatersrand, Johannesburg, South Africa

(4)

Wits Plus, Centre for Part-Time Studies, University of the Witwatersrand, Johannesburg, South Africa

Eliphas Ndou

1.1 The Book Fills the Following Policy Research Gaps Stated Below

1.2 The Main Policy Lessons Based on Evidence in the Book

References

End Abstract

The South African economy has been growing at a slow pace since the onset of financial crisis in 2007. The economy experienced recessions in the 2009Q1–2009Q3 and 2018Q1–2018Q2 periods. The weak and volatile economic growth does not lead to high job creation. In addition, the subdued growth will not contribute in reducing high unemployment, high income inequality, and may exacerbates other socio-economic imbalances. Given this context the South African policymakers have pointed out in several occasions the need for structural reforms to grow the economy. Below we state the recent developments, which are core for the discussions in the book:

• World Bank (2018) report indicated that South Africa has the highest income inequality in the world.
• After the recession in 2009, economic policy uncertainty increased significantly.
• There is increased companies cash holdings in the form of bank deposits post the recession in 2009.
• There is weak gross fixed capital formation contributions to overall GDP growth.
• Monetary policymakers strongly emphasised the importance of the 4.5% midpoint of the inflation target band.
• South African Reserve Bank has adopted the financial stability mandate and has a macroprudential toolkit.
• Credit growth continues to be very sluggish compared to rates observed before the recession in 2009.
• The South African Reserve Bank (SARB) granted banking licences to new banking entrants, which may induce competition in many ways.
• The central bank points out that the problem of economic growth is structural in nature.

There are views from the public which suggests that monetary policy could be used to deal with growth and employment issues in the country. To the contrary, there are also views which suggest that attaining price stability supports growth and employment. What is missing in these discussions is the lack of empirical evidence from both sides in the discourse. This includes the lack of the availability of empirical evidence on (1) whether in South Africa induces redistributive effects or not, (2) when does the principle of policy ineffectiveness of demand management policy apply, (3) how does inequality impacts the monetary and macroprudential policy transmission mechanism. The policy engagements on these issues is missing despite much discussion about this in the advanced economies. This is despite monetary policymakers having indicated their desire to keep inflation below the 4.5% level. This desire has been communicated in several occasions and that keeping inflation low would protect the purchasing power of the poor. Surprisingly the influence of attaining 4.5% has not been articulated with regards to the distributional effects of financial policies. In contributing to the discussion, we examine if the new Keynesian proposition of policy ineffectiveness is applicable in stimulating demand or if there are no redistributive effects. Despite the differences which may arise among policymakers, it is important to determine if the income distribution matters for the effectiveness of monetary policy transmission mechanism, price stability, and financial stability.

We consider the macroeconomic effects of the preceding developments in writing this book. Each chapter provides the highlights of the main findings and policy implications based on robust empirical analysis. The analysis in each chapter states the motivations, uses simple theoretical economic models, in certain empirical models we apply counterfactual analysis to offer alternative policy scenarios.

We state the main policy lessons based on the analysis, in the last section of this introduction.¹ The book is separated into the following thematic parts, which are explored in detail in the different sections.

• Income inequality, GDP growth, and inflation regimes.
• Income equality and monetary policy.
• The role of the monetary policy channel in transmitting shocks to income inequality.
• Consumption inequality, income inequality, and credit dynamics.
• Bank concentration and income inequality.
• Macroprudential policy and income inequality.
• Output-inflation trade-off and the role of inflation regimes.
• Output growth persistence and inflation.
• Economic policy uncertainty, expansionary monetary, and fiscal policy multipliers.
• Economic policy uncertainty, lending rates, credit dynamics, and companies’ cash holdings.

1.1 The Book Fills the Following Policy Research Gaps Stated Below

1.1.1 Policymakers Should Make It Clear That Income Inequality Is a Source of Adverse Macroeconomic Effects and Price Stability Is Crucial in Dampening the Adverse Effects

Income inequality has implications for economic growth and macroeconomic stability. At least two theories predict that the impact of income inequality shocks on GDP growth is ambiguous. The adverse income inequality effects theory suggests that income inequality may slow down GDP growth by dampening investment (Grigoli and Robles 2017).² Stiglitz (2015) suggests that the influence of wealth groups on regulatory processes can lead to financial imbalances, which can slow down GDP growth. By contrast, favorable income inequality effects theory suggests that inequality provides incentives for innovation and productivity improvements and this will raise GDP growth. Alternatively, income inequality may foster investment to the extent that rich people have a higher propensity to save (Kaldor 1957). The inconclusiveness in the relationship between income inequality and GDP growth requires empirical analysis. Evidence indicates that rising income inequality significantly lowers GDP growth and that price stability matters. This is because maintaining inflation below the 4.5% threshold minimises the adverse effects of positive income inequality shocks on GDP growth. The adverse effects of income inequality shocks on GDP growth are exacerbated by elevated economic policy uncertainty, depressed employment growth, weakened investment, especially residential and non-residential investment. Certainty in economic policy is needed to avert exacerbating the adverse effects of positive income inequality shocks on GDP growth. Second, policymakers should implement policy initiatives that reduce income inequality for a long time rather than transitorily. Such reduction in income inequality may stimulate GDP growth directly and the increase will be further amplified by rising investment.

The Level at Which Inflation Reduces Income Inequality Matters

We further examine the link between inflation and income inequality amidst the SARB’s preference to have consumer price inflation below the 4.5% threshold. We argue that the socio-economic benefits of the 4.5% inflation threshold have not been empirically quantified in South Africa. This includes linking the distributional effects of positive inflation shocks on income inequality above and below the 4.5% consumer price inflation threshold. Lopez (2003) suggests that price stabilisation is beneficial for reducing income inequality through the preservation of the real value of fiscal transfers.³ Evidence reveals that income inequality growth declines due to positive inflation shocks when inflation is (1) below 3% and (2) when it is below the 4.5% threshol...

Table of contents

• Cover
• Front Matter
• 1. Introduction
• Part I. Income Inequality, GDP Growth and Inflation Regimes
• Part II. Inequality and Monetary Policy
• Part III. The Role of the Monetary Policy Channel in Transmitting Shocks to Income Inequality
• Part IV. Consumption Inequality and Income Inequality
• Part V. Macroprudential Policy and Income Inequality
• Part VI. Bank Concentration, Income Inequality and Other Channels
• Part VII. Output-Inflation Trade-Off and the Role of Inflation Regimes
• Part VIII. Output Growth Persistence and Inflation
• Part IX. Economic Policy Uncertainty, Expansionary Monetary Policy and Fiscal Policy Multipliers
• Part X. Economic Policy Uncertainty and the Lending Rates, Credit and Corporate Cash Holding Channels
• Back Matter