/ 21 March 2005

Manuel and Mboweni’s tension

South Africa’s socio-economic problems require systematic interventions by the government, but the policy of an independent Reserve Bank has come to dominate the macroeconomic landscape. Increasing tensions between its tough inflation targets and the growth targets of the National Treasury have worrying implications for the pace of development.

Though the monetary policy committee (MPC) of the Reserve Bank broadly projects a positive inflation outlook for the South African economy, in its last meeting the committee raised concerns about “the sustained strong growth in domestic demand as a result of lower interest rates, tax reductions, still relatively high disposable income, positive wealth effects arising from increases in the prices of real estate, shares and bonds, and the need for expenditure on infrastructural development”.

The committee went on to warn that a shortage of productive capacity in the economy could eventually knock supply and demand out of kilter, pushing up prices.

While the MPC frets about these potential imbalances, the National Treasury is quite happy to announce that it intends to sustain growth through “increased public spending, especially on infrastructure, moderate tax relief on businesses and individuals, a sustainable deficit and a stable tax burden”.

The very things that the MPC says threaten to increase inflation are commended in the 2005 Budget Review for pumping up household expenditure and driving much-needed growth.

To resolve this problem there needs to be a much clearer statement of policy objectives for each authority, a division of labour. At present, the committee’s statements are dominated by inflationary concerns and growth is mentioned only to the extent that it threatens the inflation target. The statements by the Treasury, on the other hand, include the inflation target, but the primary concern of the budget is “sustained growth”.

The Treasury is not as explicit as the committee in saying the inflation target is a potential threat to its expansionary stance, and hence to the envisaged pace of socio-economic delivery. This explicitness of the MPC and implicitness of the Treasury reflects the dominance of monetary over fiscal policy in South Africa.

The average policy preference, given central bank independence, is likely to lean more towards inflation stabilisation than growth. This is an unfortunate scenario from the standpoint of social delivery because monetary policy does not actually deliver housing, skills development, infrastructure, health and the other socio-economic services necessary to effect micro-economic reforms.

For example, the committee is concerned about supply-side blockages such as ageing transport infrastructure, low fixed investment, and a lack of skills, yet to address this, a more free-spending fiscal policy is necessary, and that will fuel inflation. If the committee were to raise the interest rate in response to these inflationary adjustments — as it is bound to — the economy would find itself with higher inflation, higher nominal interest rates and little improvement in capacity.

In this way, the rate of social delivery is constrained and fiscal policy would appear to have crowded out private investment.

Suppose that a 3% deficit to gross domestic product ratio over the medium term is consistent with, say, a 4% inflation rate — roughly the current position — what is the implied pace of social delivery? Is this policy configuration sufficient to allow the elimination of shacks by 2014? My view is that the pace of social delivery will be slower the more the ability of the economy to respond to major changes in government spending, in this case through inflation, is suppressed.

It is therefore important to review continuously whether the inflation target is appropriate for the projected pace of capacity growth envisaged by the government. If employment is the priority factor in poverty reduction, is the target consistent with the gap between supply and demand needed to fuel new investment, create jobs and reduce poverty?

In the midst of these complex interactions, South Africans must not lose sight of the role of discretionary fiscal policy in solving their long-term problems. It is not a sin to revise an inflation target to improve the pace of socio-economic development. Inflation targeting is a tool that must serve the long-term objectives of poverty reduction, and not the other way round.

Chris Malikane is an economics lecturer at Wits University