Stable inflation suggests central bank should target balanced growth

SA could do with a mood lift, but expectations remain modest in the absence of economic structural reform

At its meeting this week the SA Reserve Bank’s monetary policy committee (MPC) will again mobilise its unquestioned expertise to review the economic outlook and decide on interest rates. Will there be another reduction, or will rates remain unchanged?

Several economists are expecting the latter, despite the recent better inflation outlook and an easing global interest rate cycle. And as an emerging market, how does SA manage a highly volatile rand, if at all?

These decisions are never clear-cut, because management of the repo rate cannot, even nowadays, be based on exact science. Despite modern economic techniques, judgment is required to interpret trends that still cannot always be exactly measured, or whose outcome will be shaped by time lags.

But where does cutting-edge economic modelling leave off and the “art of central banking” take over? We believe we understand much more today about how economies work, but we certainly do not know everything.

Economic forecasting remains particularly hazardous, with the failure of most economists to foresee the 2008 Great Recession being the most dramatic example.

Economic techniques for guiding decisions about interest rates — such as the Taylor rule or the more specific Bank quarterly projection model

— are necessary tools but not faultless ones. Their limitations must always be considered, for behind the figures used in such models are hard-tocapture questions such as levels of confidence, which should also be weighed.

Business people and consumers, whose decisions ultimately determine recorded figures such as GDP and inflation, are driven by various factors, often mixed and not always clear-cut. These have to be interpreted in assessing the balance of risks.

Monetary authorities have to use their judgment in evaluating the general situation. In its absence, it is easy to see how the much-vaunted “forward guidance” among central banks has sometimes come a cropper.

“I always ask myself the question,” former US Federal Reserve chair Alan Greenspan once said,

“what are the costs if we are wrong? If there is no downside risk, you can try any policy you want. But if the cost of failure is very large, you should avoid the policy.”

The SA economy is now widely seen to be in a poor space. It needs all the help it can get. The downside risks have been increasingly on the side of faltering growth and higher unemployment, to which the MPC statements have referred but, critics allege, not necessarily given adequate weight. Inflation is indeed hard on the poor, but so is joblessness, they assert.

The Bank remains a widely respected and highly professional institution, whose constitutional mandate and autonomy must be defended and protected. It has an excellent overall track record, enjoys credibility as well as high international standing, and makes few mistakes. It has a definitive anti-inflationary mandate combined with an inflation target decided by the cabinet, all of which need support.

But this does not mean there should not be a robust debate on the appropriate level of interest rates in a given set of economic circumstances, such as now. To analyse particular interest rate decisions in a democracy is therefore essential and promotes transparency and accountability.

Monetary policy decisions are an important part of the economic debate. Hence it is not monetary heresy for critics to suggest that, in taking a too mechanistic view of what should be the next step in interest rates, the MPC decision to raise the repo rate by 25 basis points in November 2018 was a mistake. Several analysts and economists said so at the time, though others supported it. The economy was obviously steadily weakening and the MPC itself was constantly reducing its 2019 growth forecasts during this period. The Bank subsequently conceded that a more accommodative monetary policy could have been followed then.

The decision in July 2019 to cut the repo rate by only 25 basis points merely restored the preNovember 2018 level, instead of immediately reducing it by a larger amount. This came while the MPC’s 2019 growth forecast was now down to 0.6%, with downside risks.

So, if interest rates cannot be cut further at this low growth rate, when will it happen? It is helpful, therefore, that the latest data suggests that inflation appears to have stabilised well within the official target range. This does not gainsay the overarching reality that the main challenges to SA’s growth performance still lie in the structural economic reforms SA so urgently needs.

Previous levels of interest rates are not to blame for SA’s economic plight. Nor must potentially lower interest rates be seen as a turbocharged growth engine. Indeed, in an economic situation with low domestic confidence and amid strong rumblings of international stresses, even a large cut in interest rates might only have a limited economic effect.

Expectations must therefore remain modest, failing pro-growth reforms. But this should not be used as an excuse for not setting interest rates at the right level, however marginal this change may appear in the bigger scheme of things. To the extent that monetary policy can safely be supportive, it should be seen to be so.

CONFIDENCE LEVELS

From a perception and psychological point of view, costs of borrowing remain important for business and consumers and for confidence levels. It is not only about money but also about mood. Might lower rates even possibly translate some of those “cash balances” into investment in the “real” economy to boost growth, by making holding cash reserves look less attractive?

It would be wrong, in forming expectations, to attach undue weight to factors that are very uncertain. The burden of proof for a central bank cannot be absolute certainty. Given the latest global and domestic data, a degree of flexibility in unpacking the inflation target is needed.

Recently the interpretation of the relevant data seemed skewed towards the first half of the Bank’s constitutional mandate, which is “to protect the value of the currency”. But economic circumstances now suggest a shift towards the second half —“in the interest of balanced growth and development”.

With inflation now better anchored, growth can be given the benefit of the doubt.

The September meeting of the MPC offers another opportunity to calibrate monetary policy to prevailing concerns about the true state of the economy.