INFLATION TARGETING POLICY! A misfit for South African Economy - By: JohnChikanga

For years there has a debate and an outcry around the compatibility of the Inflation Targeting Policy Framework (ITPF) that is being pursued by the South African Reserve Bank (SARB) with the developmental needs of the country. The SARB has for long time used inflation targeting as a single major monetary policy tool to maintain a tight rein on inflation, and this has culminated in a series of criticism from various business quarters and intellectual communities circle. It now appears that the general consensus among many economists and business organisations is that inflation targeting framework is a policy misfit for the South African economy. No jury of contemporary economists can agree on the satisfactory use of inflation targeting framework in South Africa; - the perceptions, views and opinions of these economic experts have been very controversial.

To many of the economists the ITPF that is being religiously pursued by the SARB is an inappropriate strategy as it is just a monitoring tool and not an economic tool. According to majority of the economists it appears that there has been a serious disillusionment on the part of the central bank regarding ITPF because inflation has been regarded as number one economic indicator. What is being forgotten and ignored is the fact that inflation is an obstacle to growth and not a consequence of growth.

Since 1970 the SARB has used different monetary policies such as Credit Ceilings and Controls used in the 1970s and Money-Supply Growth Targets employed in 1980s. This was followed by Money-Supply Growth Guidelines adopted in early 1990s and Eclectic Monetary Policy pursued in mid 1990s. In essence the eclectic monetary policy marked the genesis of the era on inflation targeting, and inflation targeting was specified for the first time in February 2000. Its adoption entrusted a single objective to the SARB; that is of price stability. Between the period of 2002 and 2003 South African inflation target was precisely defined as increases in consumer price index (CPI) i.e. year-on-year increases in CPI excluding mortgage interest costs. The inflation target (i.e. the numerical rate and time horizon) is set in consultation between the SARB Governor and Finance Minister. This approach implies that the SARB does not have complete goal independence (i.e. the setting of the objective to achieve) but has operational independence such as the choice of instruments in monetary policy decisions aimed at achieving the target. The perceived advantages that led to the introduction and adoption of ITPF were;-

  1. It makes the objective of monetary policy clear thereby improving planning in the public and private sectors
  1. It forms part of a formalised, co-ordinated effort to contain inflation and pursuit of broader economic objective of sustainable high growth and employment
  1. It provides an anchor for expectations of future inflation which should influence prices and wages setting
  1. It helps to focus monetary policy and enhances accountability of the SARB to the public

The continued dominance and practice of inflation targeting as a monetary policy tool as attested by the persistent setting of inflation rate target has derailed and dampened efforts of accelerating meaningful economic growth. Firstly, savings and not inflation is the most important economic indicator. However, since the adoption of ITPF inflation has been regarded as number one indicator of economic performance thereby indirectly relegating savings. Conventional economics wisdom tells us that savings is the most important barometer of economic performance. A higher level of savings as a percentage of gross domestic product (GDP) will signal high economic growth because high savings rate implies high pace of capital accumulation which will in turn propels high productivity. Conversely, a low rate of savings as a percentage of GDP will mean low pace of capital accumulation which will retards investments in infrastructural and industrial development thereby hindering productivity hence an indication of poor economic growth. Using inflation rate as an economic indicator may be misleading because inflation rate does not tell any meaningful story about economic growth, output or performance. In essence the inflation rate only shows the trend of prices in the economy, that is a low or stable inflation rate does not imply that the economic growth or output has been satisfactory. Instead it will only entail that the prices of goods or services have not been on an upward trend.

The inflation target is set by the Cabinet which means it is a political decision and the SARB mandate is only limited to the choice of instruments and autonomy to adjust such instruments in order to achieve the set inflation target. This purely makes the mandate of SARB difficult because the business environment prices (i.e. fuel, electricity, wages etc.) which are inflationary are not controlled. The wages and administered prices inflation falls outside the mandate of SARB but its trend have an effect on the ultimate on CPI inflation rate. For example, the administered prices inflation for year 2011 was around 13% whereas the SARB mandate was to keep the CPI inflation between 3% and 6%. This clearly shows gross lack of synergism of the ITPF that is being pursued.

The South African government traditional route of slowing down inflation has been a tight monetary policy, and such a traditional is too costly because it takes hundreds of billions of rands in gross national product gap to reduce inflation by a few percentage points. Although no one country has for long enjoyed full employment, free markets and stable prices; in South Africa the practice of inflation targeting can be the part of the reasons for high unemployment and slow economic growth that is being experienced. The practice of inflation targeting has meant that the SARB had to pursue a tight monetary policy, and this strategy has ensured reduction of money supply in the economy which led to an increase in the level of interest rates thereby tightening credit conditions. The higher interest rates have managed to reduce aggregate demand thereby reducing inflation by marinating the inflation rate within the set target range. However, this have negatively impacted on output growth and contributed to high unemployment levels as many business enterprises are operating in a constrained environment where the price of money is high and the amount of credit available limited. The high interest rates and limited amount of credit available has resulted in the decline of investments in industrial development.

The practice of inflation targeting has made the cost of doing business in South Africa high. Concisely, there is lack of policy to support internal business relations in order to ensure the success of ITPF because the wages and administered prices inflation is out of hand.

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