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In short, excess demand is highly unlikely to put upward pressure on prices for an extended period of time. However, it is possible that weak demand may constrain the pricing power of business, forcing them to absorb cost pressures or find ways to reduce costs if profit margins are to be maintained.

So it is all about cost pressures coming through from the supply side of the economy ̶ higher food prices because of the severe drought, higher imported inflation as a result of rand weakness, and sustained increases in administered prices over a long period, electricity prices in particular, in excess of general inflation. Although one could legitimately ask whether all of these are to be regarded as contributing to a rise in the general price level and whether at least some of the price changes do not rather reflect changes in relative prices that are an inherent part of the signalling function of the pricing mechanism. Suppressing the latter would in fact undermine the information content of prices that is necessary for market participants to efficiently adjust their behaviour to changed market conditions. For example, higher fresh produce prices as a result of the severe drought are necessary to balance demand with reduced supply and to encourage increased production by those who can.

In the second place, as for the matter of managing inflation expectations, the question is whether expectations are not predominantly adaptive, in other words they adjust to the ups and downs in the inflation rate as they occur. The methodology of the inflation expectations survey actually encourages expectations to be adaptive. Thus it is questionable whether measured inflation expectations reflect strong convictions about future price movements that will be factored into decision-making processes.

Although it is plausible that economic and market analysts forecast future inflation taking their expectations regarding the future path of interest rates into account, it is highly unlikely that business and labour would do so. In any case, there are indications that business pays little attention to inflation data as it is not regarded as a strategic input into business decision making. It is just not realistic to think that business people will be alert to how their individual pricing decisions feed into general inflation data and that it could trigger a response from the MPC, resulting in their refraining from raising prices.

The third element of our framework of understanding, once we have determined the causes of inflationary pressures, is our understanding of the monetary policy transmission mechanism. In exactly what way do we expect a change in the repo rate to affect the general price level, or more specifically, how do we see an increase in the repo rate addressing the inflationary pressures coming from our identified causes?

Will suppressing already weak domestic demand even further by increasing debtors’ debt service burden and upping the cost of credit do the trick? Will it weaken business’s pricing power to the point of profits taking the knock? Or will business, faced with even lower prospective demand, in any case hike prices in an attempt to try to support nominal turnover? Does the prospect of ongoing fiscal tightening for the next few years not relieve the burden of monetary policy?

The price pressures resulting from the drought and administered prices cannot be addressed by monetary policy. Food prices will normalise once supply normalises, while administered prices are a matter of policy.

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