The art of talking about a moving target
The good news for time-poor politicians is that they probably don’t need to read past the first page of the Reserve Bank’s latest monetary policy review. The bad news is that the page paints a gloomy picture for the economy, which is under pressure from external and domestic factors.
Internationally, there is the US-China trade dispute, which
if movements in global bond markets are any guide threatens to push many developed economies into a recession.
Locally, there is the country’s fiscal position, which has been worsened by the government’s decision to throw more money that it doesn’t have at failing state-owned enterprises.
The economy’s growth potential has slumped to barely 1% after supply shocks such as Eskom’s power outages and a collapse in consumer demand as well as business confidence.
A more complete reading of the document would also indicate that the Bank doesn’t see monetary policy as a solution to the growth constraints. There is the usual call for structural reforms and an emphasis that lowering rates alone will not produce the delivered growth outcomes. The likely consequence would be higher inflation, which would necessitate tighter policy at a later stage.
The monetary policy review is an impressive document crammed with interesting boxes. In the discussion about its communication strategy regarding the inflation target, the Bank noted that it had never expressed an opinion on where inflation should be within the 3%-6% range. Actual inflation and expectations thus became stuck at about 6%, turning the upper end into the de facto target.
From about 2017 it changed its communication, with an emphasis on its preference for inflation to be anchored in the midrange of the target, about 4.5%. In a self-congratulatory box, the Bank charts its success in changing the narrative about the target, noting that it is replicated in analysts’ and media reports.
“These results provide evidence that sustained central bank communication shapes media and analyst reporting on monetary policy,” it says.
This enabled the Bank to push inflation from the upper end of the 3%-6% target range to about 4%-4.5% now without having to raise interest rates, as suggested by its own studies. It had assumed that to establish the credibility of its midpoint objective the repo rate, which is now at 6.5%, would have to rise to about 8.5%.
So far so good. But the Bank left out a crucial point. In much of the reporting the language about the 4.5% objective has changed, with analysts and journalists talking about the number as a target. That probably explains much of the criticism aimed at the Bank when it doesn’t cut rates despite inflation being comfortably entrenched at or below the midpoint of its target range.
People who perceive the midpoint as a de facto target understandably hold the view that the Bank should be cutting interest rates when inflation dips below 4.5%. They have largely forgotten about the 3% part of the range. It might have been better for the target to be expressed as 6%-3% to entrench the notion that the idea is to get inflation closer to 3%.
Does it make sense for the country to be targeting 4.5% inflation when its major trading partners are aiming for about 2%? This means we are constantly accepting that the value of the rand will continue to drop, based on inflation differentials with our major trading partners.
There would be less controversy about the Bank’s decisions if it was clear that the objective was to get inflation towards 3%. With 4.5% perceived as a target, its failure to cut rates now invites accusations that it has neglected the second part of its mandate, which is to help produce “balanced and sustainable economic growth in SA”.
Now might therefore be a good time for the Bank to once again rethink its communication strategy. And who knows, it might even be able over time to get inflation closer to 3% without the need to hike rates.
Those who see aggressive rate cuts as the panacea for the country are likely to be disappointed there is nothing in the review that would make one think that substantial rate cuts are on the way.
The ball is in the government’s court, and much will depend on finance minister Tito Mboweni’s medium-term budget policy statement at end-October.
DOES IT MAKE SENSE FOR SA TO TARGET 4.5% INFLATION WHEN ITS MAJOR TRADING PARTNERS ARE AIMING FOR ABOUT 2%?
NOW MIGHT THEREFORE BE A GOOD TIME FOR THE BANK TO ONCE AGAIN RETHINK ITS COMMUNICATION STRATEGY