Inflation targeting put before growth

SOUTH Africa formally adopted inflation targeting as a monetary policy framework in 2000, having adopted other frameworks between 1960 and 1998.

These included exchange rate targeting, discretionary monetary policy, monetary aggregate targeting and an eclectic monetary policy approach. Simply, inflation targeting means the Reserve Bank sets a target range in which inflation is palatable for the economy.

South Africa’s range is 3% to 6% for a year-on-year increase in headline inflation (CPI). Any meaningful deviation from that range would ordinarily result in the central bank increasing interest rates when the deviation is above the range and reducing rates when the deviation is below — economics 101 . . . or is it?

The challenge facing the central bank is that our economy is experiencing stagflation — stagnant or slow economic growth, high unemployment and inflation, all at the same time.

This is a challenge because the responses to low growth, unemployment and inflation are systematically opposed by design.

Policies designed to deal with high inflation tend to make the economic environment increasingly difficult for the unemployed and low-income earners. At the same time, policies designed to deal with high unemployment will ordinarily result in higher inflation.

Milton Friedman, the 1976 Nobel laureate, was the first meaningful challenger of Keynesian economics when in the ’60s he argued for the possibility of stagflation — an environment where Keynesian economic theories wouldn’t hold. Friedman argued that “once people adjusted to inflation, unemployment would rise again unless the underlying causes of joblessness were addressed”. To put things in context, these are some South African statistics:

Unemployment increased to 25.5% according to the thirdquarter 2015 Quarterly Labour Force Survey by Stats SA. One would expect this figure to worsen in the coming year given that many companies across sectors have signalled retrenchments, including Telkom, Absa, Anglo American and ArcelorMittal SA;

The IMF has cut the country’s growth outlook this year to 0.7%, down from a previous 1.3%; and

The Reserve Bank recently warned that the economy faced a prolonged breach of the inflation target because of higher food prices and exchange rate depreciation — cost-push inflation. Inflation accelerated to 7% in February this year and is expected to peak at 8.1% by December, according to Nomura economist Peter Attard Montalto. The central bank has raised rates four times since July last year in an attempt to curb inflation.

In an environment where the government doesn’t have much room to manoeuvre in fiscal policy, the monetary policy committee’s mandate has largely been a dual one: stimulating growth and managing inflation — the former of which the Reserve Bank seems to have abandoned.

As a result, the consumer will continue to be squeezed.

Banks are budgeting for an

The challenge to the bank is that the economy is experiencing stagflation

increase in nonperforming loans as debt repayments rise, with no commensurate increase in wages. As mentioned, companies are gearing for more retrenchments.

Higher unemployment will continue to put downward pressure on wages.

And there seems no signs of meaningful economic growth on the horizon.

Friedman argued that in a stagflationary environment, the causes of unemployment had to be addressed before the economy could recover, and it is evident that the central bank has not heeded consideration of this view.

Its strict inflation targeting blinkers it, with no view on stimulating growth, and monetary policy will continue to be ineffective in positioning the South African economy for long-term, sustainable growth.

Skenjana has an MSc (finance) from Esade Business School in Spain and a BBusSci (finance honours) from the University of Cape Town. He is an independent adviser and research consultant on African industry, financial and capital markets