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Inflation targeting: Poisoning the well?

Jul 16 2017 06:00
Dewald Van Rensburg

Johannesburg - Critics of the inflation targeting mandate set by the SA Reserve Bank have never argued that inflation is harmful or positive.

However, the finer points of the long-standing argument are now getting lost in the aftermath of Public Protector Busisiwe Mkhwebane’s attempt to change the central bank’s mandate.

Reserve Bank governor Lesetja Kganyago has since taken several jabs at people whom he accuses of promoting “monetary populism”.

Addressing an audience at a function on the day that Mkhwebane’s report was released, he said: “Through history, some countries have tried to deny these truths, pretending that high inflation somehow begets sustainable growth.”

And last week, in a note issued by the central bank directing people to “base the monetary policy discussion on facts”, Kganyago characterised his opponents in a similar way .

“It would appear from the present discussion that some proponents of a new approach to monetary policy favour higher inflation,” he wrote.

The problem with that is that no one has actually ever said that inflation itself does any good.

Trade federation Cosatu, a long-standing enemy of strict inflation targeting, has always argued for a mixed mandate like that of the Federal Reserve, which incorporates an employment target alongside an inflation target.

This is par for the course, said Neva Makgetla, a senior economist at the not-for-profit research firm Trade and Industrial Policy Strategies.

“People who want a very tight monetary policy tend to caricature their opponents as not caring about inflation at all,” she told City Press.

Following Mkhwebane’s report, Neil Coleman, Cosatu’s strategy coordinator, wrote a summary of the long standoff existing within the governing alliance around monetary policy.

These debates have “unfortunately been tainted by the poisoned political climate ... making it extremely difficult for a rational policy discussion to unfold”, he said.

Even economists who oppose the central bank’s inflation targeting mission have recoiled from Mkhwebane’s report.

Last week, 78 academics and economists, many of whom are against inflation targeting, signed an open letter slamming Mkhwebane’s “uninformed and rash statements”.

Instead of being a “well-intentioned, even if plainly wrong, intervention”, they cite the “very, very high” likelihood that it is a conscious attempt to undermine the Reserve Bank’s governance.

THE ARGUMENT AGAINST INFLATION TARGETING

Stephanie Seguino, professor of economics at the University of Vermont in the US, has written critically about South Africa’s inflation targeting regime.

“The goal of macro policy should be to raise living standards and to promote employment growth. Controlling inflation is a means to that end, not the end itself,” she told City Press.

“The range of 3% to 5% is too low. Research shows that inflation rates below 15% to 18% do not have a negative effect on growth. Some of the most rapidly growing economies – such as South Korea and China, and more recently, Ethiopia – had inflation rates above 10%.”

WHAT IS ‘HIGH’ INFLATION ANYWAY?

“Part of the problem is that inflation fell worldwide in the late 1990s, for reasons no one has quite clarified,” said Makgetla.

One theory is that the global flood of low-cost Chinese products “effectively reflected the inclusion of large amounts of cheap labour in global markets” and drove down prices for all sorts of things.

Globally, this has led to a complete redefinition of what constitutes “high” inflation, said Makgetla.

“Back in the 1990s, a 10% inflation rate was quite common and not seen as hyperinflation. In any case, inflation below 20% is not hyperinflation by historical measures. But most economists would prefer to stay well below 10% as the maximum.

“The question is not what the ceiling should be – it is how we should balance issues around growth versus inflation,” she added.

‘IT WON’T WORK HERE’

Defenders of the inflation targeting regime point out that South Africa’s unemployment is structural and largely impervious to monetary policy.

Annabel Bishop, chief economist at Investec, estimates this structural element at 22 percentage points of the 27.7% official unemployment rate.

“This means that even if we cut interest rates substantially ... these interest rate cuts would not reduce unemployment to below 22%,” she wrote after the release of Mkhwebane’s report.

“The current broad academic consensus is that the South African unemployment rate is inelastic and not responsive to changes in the interest rate,” said Cobus Vermeulen, an economist at the University of SA.

Vermeulen recently published a paper attempting to measure the applicability of the so-called Phillips curve to South Africa’s economy.

This is a proposition, dating from a 1958 essay by economist Alban William Phillips, that there is historically a positive relationship between inflation and employment.

“Current data – globally as well as in South Africa – does not support the relationship anymore,” Vermeulen told City Press.

BUT INFLATION IS STRUCTURAL TOO

The counterargument is that inflation itself also has a specific structural make-up in countries such as South Africa that militates against inflation targeting.

“Inflation targeting causes inflation to fall by raising interest rates,” said Seguino.

“It acts on the demand side of the economy, whereas in many developing countries, including South Africa, inflation is a supply side phenomenon. If the problem is on the supply side, tightening the money supply in no way addresses the root causes of inflation.

“The policy tool is the wrong one for the problem at hand ... it simply raises the cost of credit and hurts employment.

“This has a negative effect on workers and their ability to invest in their children, with long-running negative effects.

“There are other tools at the central bank’s disposal, if it chose to use them – such as capital controls and asset-based reserve requirements – to incentivise credit to sectors of the economy where there are supply bottlenecks that contribute to inflation,” said Seguino.

Makgetla agreed that monetary stimulus could not overcome structural unemployment directly.

“That said, the kinds of programmes needed to address structural joblessness ... won’t work if the whole economy is slowing.”

South Africa had seen fiscal and monetary policy tightened alongside slow growth, she noted.

“No one can defend that as optimal, even if they think it is unavoidable. For me, the question is how to come up with more innovative approaches to both,” concluded Makgetla.

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public protector  |  sa reserve bank  |  inflation

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