What should the Reserve Bank do if the exchange rate, as determined by the markets, moves away from what it considers to be a competitive level? This question comes to mind when one looks at two Monetary Policy Committee (MPC) statements made two years apart.
In March 2003 the committee said: ‘We have no intermediate policy targets or guidelines and we are committed to allowing the value of the rand to be determined by the market.” And last Thursday the MPC made it clear that ‘it remains the view of the MPC that a competitive and stable exchange rate would contribute to sustainable growth in output and employment”.
When such situations arise we may justifiably refer to the central bank’s mandate as incomplete. When the rand dramatically depreciated in late 2001, the subsequent policy stance was a series of measured increments in the interest rate. It was then argued that the negative effects on growth of these increases would be counter-balanced by the competitiveness of exporters.
Nothing was mentioned about the accompanying job losses and the possible unbalanced effects of exchange rate fluctuations on employment in the export and import sectors.
For example, depreciation may stimulate exports and raise employment to a certain degree. But an appreciation may lead to an export contraction, accompanied by an even greater degree of employment reduction. We gain far less on the roundabouts of a weaker rand than we lose on the swings of a stronger one.
Given that South Africa’s main problem is unemployment, it appears prudent to adopt a policy with a strong bias against appreciations. But this would require that the mandate of the Reserve Bank include the exchange rate. This involves a move away from reliance on exchange-rate appreciation to achieve the inflation target.
It is therefore heartening to notice the word ’employment” appearing in the past two MPC statements. The last time this word made it into the statement, in passing, was on October 16 2003. Last week it made a forceful re-entry: ‘Robust economic growth has been accompanied by six consecutive quarters of employment growth in the formal non-agricultural sector.”
It should not be surprising that employment is not a regular feature in MPC statements. The theoretical foundation on which the Reserve Bank’s mandate rests asserts that the MPC cannot influence businesses decisions to hire and fire in the long term. But some in the public know better. If one is fired at age 45, one stands a strong chance of not being employed elsewhere.
The recent Labour Force Survey recorded a slight improvement in unemployment, from 27,9% to 26,2% between March and September 2004. This led to hopes that we have turned the corner. At almost the same time DRD Gold, Harmony Gold and Ingwe announced intended retrenchments.
The exchange rate is spoiling the party. There is broad agreement that over the past decade South Africans have increased their productivity. Trouble is, the exchange rate may strengthen as a result. However, even if the current levels were based on productivity growth differentials with our trading partners, the social costs of allowing the exchange rate to float freely are enormous.
Imagine what happens to the labour-intensive mines and agriculture when the financial sector and some manufacturing firms pull the average productivity up and thus strengthen the exchange rate.
Apart from the skills mismatch, even the growing sectors may be too capital intensive to attract workers released by failing sectors.
For this reason alone policy should be sensitive to employment adjustments. The MPC should begin to monitor employment and not simply focus on the extent to which the exchange rate affects the inflation forecast.
I believe that, based on its econometric models, the MPC has an idea of what a competitive, employment-enhancing exchange rate is.
It also knows that there is an optimal rate of appreciation in the face of productivity gains, such that the social costs of accompanying job losses are minimised. We should thus broaden the mandate of the Reserve Bank to manage the exchange rate at the level around which it thinks it should fluctuate, and not blame the MPC for following its rigid constitutional mandate.
Chris Malikane is an economics lecturer at Wits University