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Monetary Policy for dummies

April 17, 2024
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FinMeUp
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FinMeUp

Monetary Policy. What is it, who is responsible for it, and why should you care? Lets dive in.

 

If Inflation is too high, the SARB must _____ interest rates which will lead to a(n) _____ in borrowing from individuals and firms.

  1. increase / increase
  2. decrease / decrease
  3. decrease / increases
  4. increase / decrease

 

The South African Reserve Bank (SARB)

Origin

The South African Reserve Bank is the central bank of South Africa. It was established in 1921 after Parliament passed an act, the "Currency and Bank Act of 10 August 1920", as a direct result of the abnormal monetary and financial conditions that World War I had brought.

Primary mandate

The primary mandate of the South African Reserve Bank is to protect the value of the currency in the interest of balanced and sustainable economic growth. 

Other responsibilities 

The SARB is also responsible for:

  • issuing and destroying banknotes and coins
  • regulating and supervising financial institutions
  • managing the official gold and foreign reserves of the country
  • managing the national payments system
  • administering the countrys remaining exchange rate control systems
  • acting as the banker to the government
  • acting as lender of last resort to provide liquidity assistance

 

Monetary Policy

Price stability

As mentioned above, the primary mandate of the SARB is to protect the value of the currency. What does this mean? In simple terms: Price stability, or low inflation.  How do they achieve this? By managing the money supply via interest rates.

Interest rates

Long story short the whole economy is built on debt. So, the main tool used to control the issuance of debt, as well as the price we pay for it (interest), is interest rates.

When prices are rising too fast, the SARB will increase interest rates. This is known as contractionary monetary policy. The effect is twofold:

  1. This will force individuals, firms, and the government to repay more interest on their existing loans, thus decreasing the amount of money in the system.
  2. Higher interest rates will disincentivise the acquisition of additional debt because the price of debt is now more expensive.

Conversely, when prices are rising too slowly, the SARB will decrease interest rates. This is known as expansionary monetary policy. The effect is twofold:

  1. This will result in lower payments on existing debt, increasing the disposable income in the economy.
  2. Lower interest rates will incentivise the acquisition of additional debt because the price of the new debt will now be cheaper.

In short:

  • Higher interest rates - less money in the economy - lower inflation
  • Lower interest rates more money in the economy - higher inflation

 

If Inflation is too high, the SARB must _____ interest rates which will lead to a(n) _____ in borrowing from individuals and firms.

  1. increase / increase
  2. decrease / decrease
  3. decrease / increases
  4. increase / decrease

 


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