Lesetja Kganyago. (Waldo Swiegers/Bloomberg via Getty Images)
Over the last year or so, the attention of markets has been fixed on every move made by central bankers. Stakes are high and, after a couple missteps, it is no wonder bondholders are on edge.
Although some argue that there is no clear connection between financial market volatility and economic policy, there are periods in which expected policy developments influence price dynamics and vice versa.
There is an important lesson that ought to accompany fears of market reactiveness: the economic policy decisions that are made today, when economies are on the brink, could leave scars that will only start fading decades from now.
Last week, the South African Reserve Bank lifted the repo rate by 75 basis points in a move that took nobody by surprise.
The aggressive hike was like a punch in the gut to many, but — as I’m sure some analysts would say — the decision was a necessary one to satisfy volatile financial markets, which are allergic to surprises.
Especially now, every decision, good or bad, comes at a cost.
Reserve Bank governor Lesetja Kganyago somewhat euphemistically refers to these as trade-offs. Euphemistically because, in our current economic conditions, most have little left to trade and there is even less to gain in return.
If we use the rather simplistic “ahead of the curve” versus “behind the curve” dichotomy, we can begin to distinguish between what is believed to be a good monetary policy decision and a bad one.
In contrast to his colleagues in some advanced economies, Kganyago has been associated with the camp “ahead of the curve”, which basically means the Reserve Bank acted on inflation before it was too far gone.
It must be noted that today’s good can easily become tomorrow’s bad, and vice versa, depending on whatever shock lies ahead. That said, the virtue of being ahead of the curve is that there is more room, monetary policy-wise, to adjust when those shocks come about.
The governor hasn’t exactly embraced the ahead-of-the-curve label, not wanting to pat himself on the back prematurely.
Speaking after last week’s repo rate announcement, Kganyago said: “Are we ahead of the curve? Are we on the curve? Are we behind the curve? You can only tell that in hindsight. Remember, we determine policies based on our inflation and growth outlook and the risks attendant to that.”
Indeed, the Reserve Bank relies on its forecasts to make judgments about price dynamics and the path of monetary policy. But that doesn’t mean that errors in judgment can’t be made.
This is where camp “behind the curve” comes in.
The United States Federal Reserve is largely regarded as having fallen behind the curve. This is because, despite signs of overheating, that central bank took more of a wait-and-see approach to inflation, taking a lot longer before raising its policy rate.
The problem underlying that approach has now come to bear: because inflation is far more stubborn than expected, the Fed has had to raise rates faster, inflicting more acute pain on the economy.
A downturn stateside is now on the cards. The November Federal Open Market Committee meeting minutes signal as much, noting that Fed staff “viewed the possibility that the economy would enter a recession sometime over the next year as almost as likely as the baseline”.
But before we judge the Fed’s decision-making as wholly good or bad, it is important to also understand its motives.
On top of aiming to achieve price stability, the Fed is also mandated to achieve maximum employment. These two metrics are closely linked, especially in the context of overheating.
As was the case in many other economies, the Covid-19 pandemic shook the US labour market.
The Fed’s looser approach to monetary policy was coloured by the memory of high unemployment after the global financial crisis.
Since then, the Fed has changed tack, stating its belief that the economy can sustain much higher employment without stirring inflation than it had previously thought, meaning there was no need to keep interest rates as high.
The problem came when economic growth, accommodated by low interest rates, did not necessarily translate into higher levels of employment.
After the pandemic many in the US were more hesitant to return to the job market — and they didn’t have to because stimulus cheques and low interest rates were enough to keep many going. But, when demand started to outstrip supply, the price of labour ratcheted up, driving inflation.
The Fed pushed monetary policy beyond its limits, some argue, and it is now working to correct this error, bringing employment down as a result.
In a sense monetary policy is a cycle of corrections. Decisions are made to correct imbalances, but there is always the risk of over-correcting. Often these imbalances exist because fiscal and monetary policies are not doing what they ought to, creating a ripple effect that can last lifetimes.
Remember, inflation is best managed in advance. What the US is dealing with now is partly the result of poor economic policy in the 2010s.
Despite the ultra-low interest rates post financial crisis, public investment plummeted stateside. Instead, they became a drag on productivity growth, with which the US continues to battle. Higher levels of productivity temper inflation.
Similarly, South Africa is counting the cost of fiscal misallocations made over the past decade.
Today, near stagnant growth and ultra-high unemployment have given credence to calls to keep interest rates low, but the Reserve Bank insists it will not target these two metrics if it means abandoning its fight against inflation.
Policymakers — who have kept a tight grip on the strings of the public purse despite calls for more stimulus — missed the opportunity to increase public investments during pandemic-era low interest rates.
Instead, our economic recovery has been put on the shoulders of a hesitant private sector, with the government helping by implementing structural reforms.
Growth will continue to move at a glacial pace. And, in the meantime, more scars will form.