Growing pains

RESERVE Bank Governor Gill Marcus has broken her silence over the new growth path (NGP), which envisages a looser monetary  policy.

In a very subtle way, she criticised some of the tenets of the NGP in a speech, and also emphasised that it needs to be implemented as a coherent whole.

She summed up the way the NGP envisages monetary policy: "According to the new growth path, macroeconomic policy will be guided by 'a looser monetary policy and a more restrictive fiscal policy backed by microeconomic measures to contain inflationary pressures and enhance competitiveness...

"'The monetary policy stance will continue to target low and stable inflation, but will do more to support a more competitive exchange rate and reduced investment costs through lower real interest rates. This will be accompanied by measures... to contain inflationary pressures and enhance competitiveness.'
 
"These latter measures included more effective competition policies, and a review of administered prices to ensure that their increases were not higher than inflation unless there were compelling reasons. Furthermore, the proposals included a social accord to moderate or cap wage and salary increases."

Trade federation Cosatu responded to this when it was first announced by saying the union had been "accommodated" on interest rates.

Stable inflation still Sarb's aim

Marcus made it clear that it hadn't: "Our interpretation of this is that the proposals recognise that the bank's mandate remains the achievement of low and stable inflation."

She acknowledged the theoretical rationale for a tight fiscal policy and loose monetary policy, but had many veiled criticisms of the approach. 

Marcus said at this stage, further work had to be done to determine the degree to which fiscal policy needed to be tightened to support monetary policy in this way.

It was also not clear that fiscal policy had the flexibility to take over the role of monetary policy as an anti-inflation policy on a cyclical basis. Discretionary changes to the fiscal policy stance took time to implement, unlike in the case of monetary policy.

Marcus said the current fiscal policy stance was tighter than at the height of the crisis, but the estimated structural deficit of about 4% represented a much looser stance than was the case during 2000 to 2008, when it was generally well below 2%.

Similarly, real interest rates are currently much lower than was the case over past years. The long-term real repurchase rate had averaged between 3% to 3.5% over the past decade. The current real repurchase rate, assuming an expected inflation of about 4.5%, was equivalent to 1%. Should inflation surprise on the upside, this real rate would decline as well.

This suggested that currently both fiscal and monetary policies are relatively loose, which in our view was appropriate for the current state of the economy and the low global real interest rate environment. However, should the economy, particularly domestic expenditure, start to pick up significantly, this mix would have to be changed.

That Marcus thinks monetary  policy is already loose should come as bad news to anyone thinking the NGP signals much further action on the interest rate front. She also made it clear that the other reforms in the NGP had to take place before further movement could be expected from the Reserve Bank.

"Monetary policy cannot be loosened in advance of these other reforms, unless there is a clear notion of the extent of fiscal tightening and certainty about the time horizon over which microeconomic reforms can be effectively implemented and achieve results.

Bank needs flexibility to do its job

"In the absence of such coordination, excessively low real interest rates will not necessarily bring about increased investment. They are more likely to result in higher inflation and consequently higher long-term interest rates, which will impact negatively on the cost of government borrowing and the cost of capital.

"Under such circumstances, real long-term interest rates are likely to rise even further because of a possible increase in the risk premium."

She emphasised the need for other policies to be in place: "To the extent that other policies and microeconomic interventions are supportive, we will have greater flexibility in the conduct of monetary policy.

"We have to be realistic about what monetary policy can achieve in solving an unemployment problem that is essentially structural in nature."

She made the point that, in advocating the macro policy mix of tight fiscal policy and loose monetary policy, there was an underlying assumption that the main determinant of the exchange rate was the interest rate differential, and that lower domestic interest rates would reduce interest-sensitive capital flows.
 
"However, experience has shown us that reality is not so simple. There have been periods in the past, and this was true for much of the 2000s, when capital inflows were dominated by flows into equity markets. In other words, capital was attracted by growth prospects rather than interest rate yield differentials."

She also said it wasn't always possible to achieve the goals of low and stable inflation, a competitive exchange rate and low real interest rates simultaneously.

There were unfortunately times when conflicts between these objectives would arise, and the bank should be in a position to act independently, in line with its constitutional mandate, when such a situation arises.
 
All in all, a pretty cold response to the NGP.

 - Fin24