INFLATION TARGETING POLICY! A misfit
for South African Economy - By: John
Chikanga
For years there has a debate and an outcry
around the compatibility of the Inflation
Targeting Policy Framework (ITPF) that is
being pursued by the South African Reserve
Bank (SARB) with the developmental needs of
the country. The SARB has for long time used
inflation targeting as a single major monetary
policy tool to maintain a tight rein on inflation,
and this has culminated in a series of criticism
from various business quarters and intellectual
communities circle. It now appears that the
general consensus among many economists
and business organisations is that inflation
targeting framework is a policy misfit for the
South African economy. No jury of
contemporary economists can agree on the
satisfactory use of inflation targeting framework
in South Africa; - the perceptions, views and
opinions of these economic experts have been
very controversial.
To many of the economists the ITPF that is
being religiously pursued by the SARB is an
inappropriate strategy as it is just a monitoring
tool and not an economic tool. According to
majority of the economists it appears that there
has been a serious disillusionment on the part
of the central bank regarding ITPF because
inflation has been regarded as number one
economic indicator. What is being forgotten and
ignored is the fact that inflation is an obstacle to
growth and not a consequence of growth.
Since 1970 the SARB has used different
monetary policies such as Credit Ceilings and
Controls used in the 1970s and Money-Supply
Growth Targets employed in 1980s. This was
followed by Money-Supply Growth Guidelines
adopted in early 1990s and Eclectic Monetary
Policy pursued in mid 1990s. In essence the
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eclectic monetary policy marked the genesis of
the era on inflation targeting, and inflation
targeting was specified for the first time in
February 2000. Its adoption entrusted a single
objective to the SARB; that is of price stability.
Between the period of 2002 and 2003 South
African inflation target was precisely defined as
increases in consumer price index (CPI) i.e.
year-on-year increases in CPI excluding
mortgage interest costs. The inflation target (i.e.
the numerical rate and time horizon) is set in
consultation between the SARB Governor and
Finance Minister. This approach implies that
the SARB does not have complete goal
independence (i.e. the setting of the objective
to achieve) but has operational independence
such as the choice of instruments in monetary
policy decisions aimed at achieving the target.
The perceived advantages that led to the
introduction and adoption of ITPF were;a. It makes the objective of monetary
policy clear thereby improving planning
in the public and private sectors
b. It forms part of a formalised, coordinated effort to contain inflation and
pursuit of broader economic objective of
sustainable
high
growth
and
employment
c. It provides an anchor for expectations of
future inflation which should influence
prices and wages setting
d. It helps to focus monetary policy and
enhances accountability of the SARB to
the public
The continued dominance and practice of
inflation targeting as a monetary policy tool as
attested by the persistent setting of inflation
rate target has derailed and dampened efforts
of accelerating meaningful economic growth.
Firstly, savings and not inflation is the most
important economic indicator. However, since
the adoption of ITPF inflation has been
regarded as number one indicator of economic
performance thereby indirectly relegating
savings. Conventional economics wisdom tells
us that savings is the most important barometer
of economic performance. A higher level of
The South African government traditional route
of slowing down inflation has been a tight
monetary policy, and such a traditional is too
costly because it takes hundreds of billions of
rands in gross national product gap to reduce
inflation by a few percentage points. Although
savings as a percentage of gross domestic
product (GDP) will signal high economic growth
because high savings rate implies high pace of
capital accumulation which will in turn propels
high productivity. Conversely, a low rate of
savings as a percentage of GDP will mean low
pace of capital accumulation which will retards
investments in infrastructural and industrial
no one country has for long enjoyed full
employment, free markets and stable prices; in
South Africa the practice of inflation targeting
can be the part of the reasons for high
unemployment and slow economic growth that
is being experienced. The practice of inflation
targeting has meant that the SARB had to
pursue a tight monetary policy, and this
development thereby hindering productivity
hence an indication of poor economic growth.
Using inflation rate as an economic indicator
may be misleading because inflation rate does
not tell any meaningful story about economic
growth, output or performance. In essence the
inflation rate only shows the trend of prices in
the economy, that is a low or stable inflation
rate does not imply that the economic growth or
output has been satisfactory. Instead it will only
entail that the prices of goods or services have
not been on an upward trend.
strategy has ensured reduction of money
supply in the economy which led to an increase
in the level of interest rates thereby tightening
credit conditions. The higher interest rates have
managed to reduce aggregate demand thereby
reducing inflation by marinating the inflation
rate within the set target range. However, this
have negatively impacted on output growth and
contributed to high unemployment levels as
many business enterprises are operating in a
constrained environment where the price of
money is high and the amount of credit
The inflation target is set by the Cabinet which
means it is a political decision and the SARB
available limited. The high interest rates and
limited amount of credit available has resulted
in the decline of investments in industrial
mandate is only limited to the choice of
instruments and autonomy to adjust such
instruments in order to achieve the set inflation
target. This purely makes the mandate of SARB
difficult because the business environment
prices (i.e. fuel, electricity, wages etc.) which
are inflationary are not controlled. The wages
and administered prices inflation falls outside
the mandate of SARB but its trend have an
effect on the ultimate on CPI inflation rate. For
example, the administered prices inflation for
year 2011 was around 13% whereas the SARB
mandate was to keep the CPI inflation between
3% and 6%. This clearly shows gross lack of
synergism of the ITPF that is being pursued.
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development.
The practice of inflation targeting has made the
cost of doing business in South Africa high.
Concisely, there is lack of policy to support
internal business relations in order to ensure
the success of ITPF because the wages and
administered prices inflation is out of hand.