Should the South African Reserve Bank continue to target inflation?
Johannesburg (Sunburst Africa) -According to the South African (SA) reserve bank, the primary objective of monetary policy in South Africa is to achieve and maintain price stability in the interest of sustainable and balanced economic development and growth. Price stability reduces uncertainty in the economy and, therefore, provides a favourable environment for growth and employment creation. Furthermore, low inflation contributes to the protection of the purchasing power of all South Africans, particularly the poor who have no means of defending themselves against continually rising prices.
The SA reserve bank have stated their inflation targets between 3 and 6% though with some flexibility and in combination with other economic indicators make decisions to increase, decrease or keep interest rates constant. In recent times inflation has exceeded the 6% target. The question is whether the bank should continue targeting inflation between 3 and 6% despite increased inflation, high unemployment and high household indebtedness.
South African reserve bank switched to targeting the inflation rate in the year 2000 after changing from exchange-rate targeting, discretionary monetary policy, monetary-aggregate targeting and an eclectic approach that was used between 1960 and 1999. However, this inflation target has repeatedly been missed in recent history.
According to Harvard economist Jeffrey Frankel, the problem with inflation targeting approaches to monetary-policy targeting is that even though a particular numerical target may be reasonable when it is set, subsequent unexpected developments often make the target hard to live with. The monetary authorities are then confronted with a harsh choice between violating their announced target, and thus undermining the credibility that was the point of the exercise, or setting policy too tight or too loose, thus doing unnecessary damage to the economy.
There is need to establish monetary policy credibility in South Africa, given the history of high inflation. Though SA has declared itself to the International Monetary Fund IMF as an Inflation targeted with respect to its nominal anchor, it has difficulty abiding within this target. Given the terms of trade shock experienced in recent times and a depreciation of the rand- the SA consumers have had to pay more for petrol and other imported products with increased price of crude oil as a result of the depreciated rand, food prices and other prices have also increased. According to inflation targeting policy dictates, the SA reserve bank have tightened monetary policy with an adverse shock of decreased output
There seem to be good reason to propose that SA reserve bank should move away from inflation targeting and focus on alternatives that can reduce the impact of adverse shocks that affect output. SA needs to bring inflation down and anchoring the monetary policy on inflation targeting of between 3 and 6% will not achieve this.
If it is worth communicating a plan, it is worth choosing a plan that one can live with – clearly inflation targeting is not that plan.
Vivian Atud is an Economist and Director at Atud and Associates consulting.