Loosen the inflation-target belt

South Africa should not do away with inflation targeting, but there is room to reconsider the narrow target inflation band, say economists.

In addition, achieving the target must be made the responsibility of all government agencies and not just the South African Reserve Bank.

South Africa’s inflation target is fixed in a band of 3% to 6%.

As Reserve Bank Governor Tito Mboweni prepares to leave the post, his legacy — particularly on the touchy subject of inflation targeting — is facing renewed scrutiny.

One of the first tests his successor, former Absa chairperson Gill Marcus, will face will be her stance on inflation targeting.
But government sets monetary policy, which requires the Reserve Bank to control consumer price inflation to within one band — and it is up to the bank to implement it.

Observers have argued that this has allowed the issue to become too personalised. Mboweni has frequently been a target of criticism, particularly from the ANC’s left-wing alliance partners, including Cosatu.

One of the main tools to control inflation is interest rates, which until late last year the Reserve Bank repeatedly hiked in a bid to curb steadily rising inflation. It peaked at more than 13% just before the start of the global financial crisis.

Annabel Bishop, group economist for South Africa at Investec, argues that inflation targeting is proving ”problematic” for the central bank. This is mainly because a ”too narrow target band was chosen for a country with a double-digit inflation history and inability to reduce its unemployment rate to below 20%, let alone to 10%”, she said.

South Africa is one of 20 countries, along with the European Union, that pursue inflation targeting as part of monetary policy. Others include developing economies such as Turkey, Brazil and South Korea as well as developed nations such as Canada and New Zealand.

Inflation targets vary from country to country. Brazil has a target band of 2,5% to 6,5% and South Korea a target of 0,5% to 3%, while Turkey is targeting 7,5% in 2009, 6,5% in 2010 and 5,5% in 2011.

Bishop believes a wider band would be ”more rational” for South Africa, given its growth-related and unemployment problems.

”Since the adoption of inflation targeting, South Africa has missed the target for most of the period to date, indicating that our inflation is arguably not stable,” she said. ”With GDP growth not high enough to significantly reduce unemployment, pursuing a narrow target band is not necessarily the best option for South Africa, which is both an emerging market and one in which the overwhelming majority of the country is experiencing very low incomes or outright poverty.”

South Africa has been outside the target band for more than two years.

Bishop suggests that a better introductory band would have been around a midpoint of 5,5% — or a target range of 3,0% to 8,0% — because the low point of South Africa’s targeted rate of inflation since 2000 has been 3,0% and 3,0% is also close to the average inflation rates of South Africa’s key trading partners.

”South Africa’s inflation targeting regime should be relooked at to determine if it indeed serves the best interests of the majority of its citizens, both in the medium and in the long term,” said Bishop.

The Reserve Bank has been viewed by some as dogmatically pursuing the target, mercilessly hiking interest rates despite many of South Africa’s inflation problems being beyond the bank’s control. These include the constant hikes in administered prices — prices set by the government — rapid fluctuations in the oil price and high global food prices.

Economist Mike Schussler similarly argued that there might be room to widen the inflation target band by even a few degrees, from 2% to 7%. But he stressed that the government ultimately set monetary policy and, effectively, Mboweni was performing the task set for him.

”A central banker is not there to be popular,” he said, adding that while the target band could be reviewed, inflation targeting offered stability and continuity in monetary policy.

”Stable and transparent monetary policy is important to allow the private sector to plan ahead.”

Former minister of finance Trevor Manuel has come out in defence of inflation targeting, saying that it should not be abandoned simply because it is difficult to achieve.

But Kevin Lings, economist at Stanlib, argues that if inflation targeting were done away with, South Africa’s inflation rate would still be high relative to the rest of the world and to our trading partners.

”As a policy it is about how you implement it … South Africa’s biggest problem is not inflation, it is unemployment,” he said.

”Where government has failed is in making inflation targeting solely the responsibility of the Reserve Bank. Other countries have made it the task of various government agencies.”

He added that industrial, labour and competition policymakers, as well as state agencies like Eskom, should also have to try to combat inflation.


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Lynley Donnelly
Lynley Donnelly
Lynley is a senior business reporter at the Mail & Guardian. But she has covered everything from social justice to general news to parliament - with the occasional segue into fashion and arts. She keeps coming to work because she loves stories, especially the kind that help people make sense of their world.

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