Treasury weighs in on lower target
• Lowering inflation target would make SA more competitive, it says
The Treasury has hinted that it could look to lower SA’s inflation target to make the economy more competitive and ease the pressure on the rand, a move the Reserve Bank has long been keen on.
The Treasury has also urged the Bank to be more upfront about the effect of fiscal policy on inflation. It said technical work had begun on the appropriate level for an inflation target for the economic context and whether this should take the form of a point or a range.
The Bank had shown its ability to stabilise inflation and anchor inflationary expectations, the Treasury said. However, “the question arises as to whether the current definition of the target is the most appropriate given the inflation differentials compared to our peers and trading partners.”
Still, the Bank made it clear that “any possible future decision must be based on evidence and communicated in a transparent manner”.
The comments from Treasury came in a Macro-Economic Policy Review that was released as part of Wednesday’s package of budget documents.
Inflation targeting had broadly achieved its goals, with inflation being lower and more predictable than before, enabling the Bank to keep interest rates low by historical standards, the Treasury said. “Nevertheless, inflation rates are higher than those of SA’s peers and trading partners, with adverse effects on competitiveness and putting pressure on the exchange rate,” the report said.
It added that administered prices — those set or regulated by the public sector — tended to rise more quickly than other prices and were a key challenge, while fiscal policy complicated the management of inflation, forcing monetary authorities to tighten interest rates more than they would have otherwise.
The review, which spelt out the negative effect of SA’s public finances on borrowing costs across the economy, recommended that the Bank more explicitly discuss the impact of fiscal policy on its inflation and growth projections, as part of transparent co-ordination between the Bank and the Treasury.
The inflation target range was set at 3%-6% when the government implemented the policy to anchor monetary policy in 2000. Plans to lower it to 3%5% never went ahead.
But since 2017 governor Lesetja Kganyago has made it clear the Bank is effectively targeting the 4.5% midpoint of the range, to anchor inflation expectations and the inflation rate at that point instead of allowing it to hover near the top of the range.
That helped to bring SA’s inflation rate down to an average of 4.5% between 2017 and 2020
without much economic pain, giving the government space to respond to support the economy throughout the Covid-19 crisis.
Kganyago has long argued, however, that at 4.5%, SA’s target is well above that of its emerging-market peers, whose targets are closer to 3%, hampering SA’s competitiveness.
In an opinion piece for Business Day on Monday, the Bank’s head of research and member of the monetary policy committee, Chris Loewald, called for an ambitious approach, saying the Bank’s high credibility enabled it to move to a better and lower inflation target, closer to those of SA’s trading partners.
“A lower inflation rate and the premium would help set off a virtuous cycle of currency stability, lower long-term borrowing costs and stronger growth and investment, improving the welfare of all households — especially those at the bottom end of the income distribution,” Loewald wrote. For now the main priority was to get inflation back to target “but ambition is also warranted”, he added.
Treasury director-general Duncan Pieterse said in the introduction to the policy review that such reviews were becoming global best practice, but key reasons in SA were the economy over the past 15 years and contestation over the role of fiscal and monetary policy.