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10 questions that explain the battle for the Reserve Bank

Jun 18 2019 12:45
Malan Rietveld

Should the South African Reserve Bank be nationalised?

Can the government print money? What does ANC secretary-general Ace Magashule mean by quantitative easing? Dr Malan Rietveld lays out the battle for the soul of the central bank. 

1. What is the SARB and what does it do?

The SARB is South Africa's central bank. It is our equivalent of the Federal Reserve in the United States or the eurozone's European Central Bank. It is not a commercial entity but rather is responsible for monetary policy and the supervision of our banking system.

2. What do you mean by “monetary policy”?

In short, it means the central bank sets the interest rate. The SARB's Monetary Policy Committee (MPC) sets the central bank's all-important policy rate (repo rate).

he repo rate, in turn, affects the interest rates that individuals and businesses - either as savers/lenders or as borrowers - face on their financial assets and liabilities.

Monetary policy has immense power over the total amount of, and the balance between, total borrowing and lending in the economy. At all times, the key constraint on lowering the interest rate (thereby favouring borrowing over saving/lending) is that it will lead to inflation if interest rates are too low.

3. What are the current political discussions around the SARB about?

There are really three related issues under discussion. First is the issue of the ownership of the SARB - the so-called “nationalisation” debate. The second is around the monetary-policy mandate. The third is around the suggested use of “quantitative easing” by the SARB.

4. What would it mean to “nationalise” the SARB?

This debate has been around for a number of years now. But it is, at best, a red herring; and, at worst, a smokescreen for efforts to reduce the independence of the central bank and change its mandate in a more populist, politicised direction.

It is true that elements of the SARB’s ownership are somewhat unusual, notably the existence of private shareholders. But the existence of private shareholders is completely inconsequential to what really matters: the mandate for monetary policy, which is set by the government and the conduct of monetary policy, which is pursued by the politically independent MPC.

As the SARB is not a profit-driven entity, but rather a public-policy institution, “ownership” is a bit of misnomer – the private shareholders have no say in any matters of consequence to what the SARB actually does.

5. What does “independence” mean in the context of monetary policy?

Independence means that the central bank makes monetary-policy decisions in a non-political way. The big political problem with monetary policy, not just in South Africa, but in all cases worldwide, is this: a reduction in interest rates can and typically will produce a short-term boost to the economy, as borrowing becomes cheaper. However, if there is no offsetting increase in the productive capacity of the economy, this boost eventually (over a year or two) results in higher inflation.

This is not rocket science and it is not controversial economics. The problem is that politicians, if left in control of monetary policy, will always be tempted to give the economy that temporary boost - particularly, say, a year or so before an election.

The inevitable but delayed increase in inflation will then be "tomorrow's" or "somebody else's" problem. The current SARB mandate appropriately identifies achieving and maintaining price stability as the primary objective of monetary policy. The achievement of low and stable inflation is both the SARB’s responsibility and the most significant contribution it can make to balanced and sustainable economic growth in South Africa.

6. Is the SARB currently independent?

Central bank independence is always a matter of degree, as politicians still have the power to set the mandate for monetary policy and make (or influence) key appointments to policy committees.

That said, the SARB enjoys an impressive degree of independence, particularly for an emerging market economy. In fact, one of the biggest economic achievements in post-apartheid South Africa has been the establishment of a highly competent, independent MPC, which pursues a clear mandate through a well-articulated policy framework of inflation targeting.

Note that this was achieved under the SARB’s existing ownership structure. This is why debates around the SARB’s ownership or “nationalisation” are most likely just political code word for reducing its independence and clarity of mandate.

7. With respect to the mandate, would it not make sense for the government to instruct the SARB to create jobs and stimulate economic growth?

This would be a disaster. The basic problem is that, beyond maybe the very short run, the central bank can do absolutely nothing to directly create jobs and increase economic growth. Yes, loosening monetary policy by cutting interest rates could provide a temporary boost to the economy. But that boost will feed through into higher prices over roughly a year.

Even before that, market participants will no doubt understand a change in mandate to mean less independent - and less credible - monetary policy for South Africa. The Rand and investor sentiment will immediately suffer.

8. What is quantitative easing?

It is a policy that has been pursued in Japan, and more recently the United States and other advanced economies. It is an absolute last-resort act of near desperation when the use of the central bank's conventional policy instruments has become either ineffective or impossible.

Usually, central banks use their policy rates as the primary policy instrument - raising interest rates when inflation threats emerge; and cutting rates when inflation forecasts are stable and the central bank thinks the economy needs a short-term boost. Quantitative easing has only come into the picture when central banks can no longer use their policy rates because they have already been reduced to zero or close to zero.

In some economies, the aftermath of financial and banking crises have been so severe that their central banks concluded that the economy still required stimulus, even after policy interest rates were cut to zero. This was especially relevant given a perceived risk of deflation (declining prices; or the opposite of inflation).

Consequently, they resorted to quantitative easing, in which the central bank prints money and uses it to buy financial assets in an attempt to encourage lending, boost investor sentiment, and stimulate a depressed economy. Quantitative easing has been controversial, as it required central banks to make more direct interventions into financial markets then they normally want to. Many economists and central bankers also argue that it has not been very effective.

9. The US introduced QE in the past 10 years, why shouldn’t the SARB?

Because it's completely irrelevant and inappropriate, given our current economic situation. First, the SARB's repo rate currently sits at 6.75% - very far from zero. If monetary stimulus was needed and warranted, the SARB could and would start by cutting the repo rate. Second, the latest inflation measures in South Africa are around 4.4% annually - we are also, therefore, hardly at risk of deflation. The SARB's inflation forecasts suggest inflation is expected to remain in its 3-6% target range.

So while we can debate whether the repo rate should and will be changed up or down, depending on inflation and economic dynamics in the foreseeable future, there is absolutely no case for quantitative easing. Those calling for the SARB to adopt quantitative easing are, very misguided and dangerously, eyeing up an opportunity to pressure the central bank into buying the debts and/or assets of troubled state-owned entities. But there is zero policy rationale for it.

10. Can the government “print money” if they take charge of the SARB?

Yes. And it’s not like it hasn’t happened in the past. It happens all the time in poorly run economies that come under pressure. It takes a while and the magnitude of the monetary disaster may vary depending on the extent of money printing, but the result is always higher inflation, and eventually hyperinflation and economic chaos.

A "take over" or "capture" of the SARB - by which I mean a loss of policy independence, rather than a change in the largely irrelevant ownership structure of the central bank, would likely be a slippery slope to monetary meltdown. First, you'd see more subtle political pressure to have lower interest rates, for example, one year before an election. Second, people will notice this, and if the SARB is seen as less independent and more politically motivated, it will lose credibility and market participants will anticipate higher inflation and a weaker exchange rate.

At that point, you either go through a painful process of reestablishing the SARB’s independence and credibility - including a period of much higher interest rates, which would cripple growth - or you lose control completely, and the government starts printing money to pay its obligations. These might include paying for food imports or the debts of the national government and state-owned enterprises. Of course, this is not sustainable at all, and inflation escalates fast, and soon you get hyperinflation.   

*Dr Rietveld is an economic consultant to central banks, governments and public investment institutions.

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