Introduction to Alliance debates on monetary policy

Debates currently raging around Monetary Policy and the role of the SA Reserve Bank have unfortunately been tainted by the poisoned political climate within which these debates are taking place, making it extremely difficult for a rational policy discussion to unfold. While many feel that elements of the predatory elite are jumping onto the bandwagon by calling for a change in the mandate of the SA Reserve Bank, for nefarious purposes; others maintain that this is part of a legitimate debate which has been pursued over the last couple of decades, and that the debate should not be shut down.

Monetary policy, together with fiscal policy, constitutes the key element of any country’s macroeconomic policy. While debates on monetary policy tend to be highly technical, they are critically important as policy choices have a major impact on the economy, and the person in the street.

This brief note cites the key moments in the development of policy on these issues. It reflects the incoherence and contestation within the alliance and government around economic policy over the last two decades, with mandated political policy being contradicted and undermined by technocratic policies driven by the Treasury and the Reserve Bank.

The debate on monetary policy and the South African Reserve Bank heated up considerably after the adoption of a 3-6% inflation target in February 2010, as the highly controversial GEAR Macroeconomic programme was due to expire. Inflation targeting effectively replaced the Gear targets, which had targeted a number of macro-economic variables (including the deficit, employment etc), albeit in an entirely problematic way.

The inflation target therefore became the central economic target, creating greater difficulties for those wanting to advance a development economic framework, as this was pursued in the context of the constitutional independence of the Reserve Bank. In simple terms this entrenched a contractionary monetary policy which used high interest rates to keep inflation low, with huge costs to the economy and development, particularly because it made investment into productive activities prohibitively expensive, and rewarded speculative behaviour.

The SA Reserve Bank itself makes little pretense that they are attempting to promote employment and economic growth. Indeed their website statement on inflation targeting explicitly states that “It is acknowledged that monetary policy cannot contribute directly to economic growth and employment creation in the long run”. This statement is arguably in contravention of their constitutional mandate to act “in the interest of balanced and sustainable economic growth in the Republic”. It is also in contrast to mandates pursued by a number of central banks internationally.

As early as 1998 COSATU raised questions about governments approach to monetary policy in its submission to the standing committee on Finance on the role of the SA Reserve Bank and Monetary Policy, and numerous COSATU Policy documents and Congress Resolutions raised concerns that the Banks approach to maintaining high interest rates was stifling the economy.

COSATU’s comprehensive input on this issue was made to the 2008 Alliance Summit, and this input is reproduced in full below. It is a highly accessible document and sets out the key issues in a manner that attempts to demystify the often complex and technical debates.

Contestation over monetary policy sharpened particularly after the development of the Global Financial Crisis in 2007/8, as it became increasingly obvious, both in SA and internationally, that restrictive monetary policy and inflation targeting was failing to achieve its objectives. COSATU advanced policy alternatives in various inputs to government, alliance etc., culminating in detail proposals in COSATU’s Growth Path document.

But while the policy of the governing party and alliance changed- see the Manifestos and Conference resolutions outlined below- this was only partially reflected in official policy statements ( eg the New Growth Path stated that ‘for the foreseeable future government will be guided by a looser monetary policy’ and governments 2009 MTSF reflected this approach) - this had little impact on monetary policy as pursued by the SARB and Treasury.

Note: Key conclusions of the relevant documents are quoted below, and all the documents are linked to their full versions on the Web, with the exception of COSATU’s input to the Alliance Summit, which is not currently available on the web.

1. COSATU Submission on monetary policy to Alliance Summit 2008 (in full below)

This submission contained the most comprehensive critique of monetary policy and the role of the SA Reserve Bank which had hitherto been articulated. It concluded: “The SA Reserve Bank is immune from accountability for its role in contributing to macroeconomic instability, low investment levels and increasing unemployment, because it is only answerable to its single target, and is politically quarantined by its constitutionally guaranteed independence. It is therefore able to maintain its focus on inflation without considering economic growth, jobs and the effects of changing liquidity on the economy… Both the mandate and structure of the Reserve Bank needs to be reviewed.”

2. Stiglitz critique of inflation targeting 2008

Stiglitz and other prominent economists sharply questioned the appropriateness of inflation targeting, even before the Global Financial Crisis peaked. He argued: “This crude recipe is based on little economic theory or empirical evidence; there is no reason to expect that regardless of the source of inflation, the best response is to increase interest rates. One hopes that most countries will have the good sense not to implement inflation targeting; my sympathies go to the unfortunate citizens of those that do. … The struggle to meet rising food and energy prices is hard enough. The weaker economy and higher unemployment that inflation targeting brings won't have much effect on inflation – it will only make the task of surviving in these conditions more difficult.”

3. ANC Manifesto 2009

A policy breakthrough was made in the ANC 2009 Elections Manifesto, which effectively took on board the arguments which had been advanced by COSATU in the 2008 Summit, stating: “Fiscal and monetary policy mandates including management of interest rates and exchange rates, need to actively promote creation of decent employment, economic growth, broad-based industrialisation, reduced income inequality and other developmental imperatives.”

4. Government Medium Term Strategic Framework 2009

Governments five year programme, intended to give effect to the Manifesto, contained a promising section on macroeconomic policy, which suggested that a new mandate would be given to the Reserve Bank: “Promoting the creation of decent employment, economic growth, broad-based industrialisation, reduced income inequality and other developmental imperatives and maintaining a stable pro-employment macroeconomic environment… Maintaining countercyclical monetary and fiscal policies and ensuring an optimal policy mix between the two policy instruments in dealing with both the short- and long-term management of macro balances and imbalances.”

5. IMF Paper questioning the strategy of Inflation Targeting 2010

An IMF Paper on “Rethinking Macroeconomic Policy” in 2010 tentatively began a debate within the Washington consensus institutions about the orthodoxy on monetary policy, questing whether key elements of monetary policy, including inflation targeting, were working.

6. Minister of Finance letter to Reserve Bank 2010

The then Minister of Finance Pravin Gordhan, in a letter to the SARB Governor, tentatively signaled a shift in the Reserve Bank mandate. However it is couched in extremely general, and limited terms: “The recession, and its negative impact on the lives of ordinary people, has taught us many lessons about the importance of pursuing policies that promote sustainable and balanced growth. It has also heightened the urgency for South Africa to chart a new growth path that allows the economy to achieve faster growth with more job creation.”

7. COSATU Growth Path for Full Employment 2010

COSATU’s Growth Path proposal contained an extensive critique of monetary policy practiced by the SA Reserve Bank, and a range of alternative policy proposals which could be followed to ensure that monetary policy supported development. This is contained in pages 75-82 of the document, and contains a number of complex policy proposals, in summary that: Employment will be the primary target of monetary policy, whilst price stability plays a subordinate role; Monetary policy will support industrial development; Foreign exchange control measures will be an essential part of monetary policy; Exchange rate management will be one of the pillars of the monetary policy framework; Reserve Bank asset and liability management will have to be aligned to our development mandate, in order to strengthen the capacity of the state and the economy to deal with the balance of payments problem; Monetary policy must support an expansionary developmental fiscal policy; A broader and more sophisticated framework of fiscal monetary co-ordination (is required).

8. National Development Plan 2012

The NDP, while conceding that ‘a balancing act needs to be struck between curbing inflation –– and keeping the embers of economic growth alive’, merely states: “The mandate of the Reserve Bank gives it the license to take factors such as the exchange rate and employment into account in conducting monetary policy” thereby washing governments hand off the matter. The NDP gave no direction as to how government should approach this issue, not entirely surprising when it is considered that the final economic chapter of the NDP was drafted by a senior Treasury official.

9. ANC Conference Mangaung 2012

The 2012 ANC Conference repeated the broad approach articulated in the 2009 Manifesto, and articulated the emerging international consensus that the approach to monetary policy needed to change, given the international experience after the GFC: “South Africa requires a flexible monetary policy regime, aligned with the objectives of the second phase of transition. Without sacrificing price stability, monetary policy should also take account of other objectives such as employment creation and economic growth. In this regard, government should engage with the new wisdom developing on macroeconomic policy around the world in response to past failures and the global crisis.” The implications of the contradictory economic policy approach adopted at Mangaung, and in the NDP, are outlined in COSATU’S discussion paper ‘Mangaung and the second phase of the transition’

10. ANC Manifesto 2014

Again in 2014, the final ANC Elections Manifesto made a general reference to the need for more developmental macroeconomic policies (although a more detailed formulation on financial and monetary policy was taken out of an earlier draft). Yet again the policy stance in the Manifesto was not reflected in government policy: “Our job creating and inclusive growth path will require macroeconomic policies that address unemployment, poverty and inequality; promotion of investment in the productive economy; addressing the poor lending practices and excessive charges in the financial sector; and making the financial sector more inclusive and accessible.”

11. Government Medium Term Strategic Framework 2014

Despite the Mangaung Resolution, the two previous Manifestos, and the 2009 MTSF, there is no coherent statement in the 2014 MTSF, which suggests that the proposed policy shifts are being taken forward. Indeed monetary policy is not mentioned in the MTSF, suggesting that it has retained its holy cow status, under the erroneous assumption that the Constitution prevents government from shaping the Banks mandate.

Neil Coleman 27 June 2017

Full text of the COSATU document from October 2008:

Alliance Economic Summit 17-19 October 2008

COSATU discussion document on Monetary Policy and Inflation Targeting

There is a strong view not only in COSATU, but the Alliance more broadly, that existing monetary policy has not contributed towards advancing the developmental objectives set out in the Polokwane resolutions, of promoting decent work, combating unemployment, inequality and poverty, and advancing an equitable growth path. The real debate is about how to ensure that monetary policy moves us forward.

Further, there is general questioning, both in the Alliance, and society as a whole, whether the regime of inflation targeting, and the use of interest rates to achieve the stipulated target range, is either desirable or effective in achieving its stated objectives Apart from anything else, the use of the blunt instrument of high interest rates to bludgeon society into reducing inflation, has been completely ineffective in dealing with exogenous factors around fuel, food etc, and we have had to live with the double whammy of high prices and high interest rates. This debate is not unique to South Africa, but is raging throughout the world. [1].

The view of COSATU, with the support of a wide range of social forces, is that the one-sided pursuit of a conservative and contractionary monetary policy regime, anchored around the targeting of inflation at an unrealistically low level, has exacted a massive price from society, and in particular the majority of our people, workers and the poor- who it is claimed the policy is designed to protect.

The main beneficiaries of the inflation targeting policy, it is argued, have been the financial sector, and those invested in the speculative dimension of the economy. The impact of high interest rates, which have been used as the major instrument to keep inflation down, has been devastating for the real economy, for jobs, and for growth in the sectors where growth is really needed. The impact of these monetary policies has been rather to fuel the speculative cycle, and the conspicuous consumption of those benefiting from its associated boom in the financial sector- the unsustainable bubble which is in the process of bursting.

COSATU has consistently argued that monetary policy needs to be realigned with the development imperatives of economic policy, outlined in numerous documents of the Alliance, and clearly set forth in Polokwane. We argued that the mandate of the Reserve Bank needs to be fundamentally shifted from the narrow inflation target, and that the Bank should be required to shape its policies based on the primary objectives of achieving growth and employment. It has been questioned whether this developmental mandate is compatible with pursuing an ultra-low inflation policy, or indeed with the use of inflation targeting.

It was based on these concerns that the Alliance Summit in May this year called for a review of the policy of inflation targeting. The Declaration stated: “The Summit took note of rising inflation driven largely by external factors. It noted that high and rising interest rates impact negatively on poor communities and on job creation. The Alliance Summit therefore calls for urgent national reflection on the appropriateness of inflation targeting as well as the ranges chosen as policy for South Africa given its developmental challenges.”

The debate around inflation targeting

A number of questions have begun to be asked about inflation targeting, anchored around a low inflation target, including:

• Is it in the interests of a developing economy?
• What are the costs to society of pursuing this policy?
• Does inflation targeting work?
• In whose interests is the policy pursued?
• Do the poor actually benefit from inflation targeting?
• Is the objective developmental or ideological?
• Are rapid growth and development compatible with an ultra low inflation target?

No less an economic luminary than Nobel prize winner Joseph Stiglitz has called inflation targeting a ‘disaster’, especially for developing economies (see attached article). He and other progressive economists have argued that such policies which pursue low, single digit inflation, are incompatible with the high-growth, and redistributive policies required in developing countries- inflation targeting by definition aims at pursuing ultra-low inflation levels, which are touted as an end in itself (just as low budget deficits were constantly emphasised in the early 90’s). They have further argued that rapid development is compatible with moderate inflation, below 20%, and pursuing low inflation targets compromises development objectives[2].

Critiques by Economists of Inflation Targeting 

Progressive economists, and even some mainstream economists, have strongly criticised the adoption of inflation targeting for a range of reasons, including the following:

• Professor Joseph Stiglitz "This crude recipe is based on little economic theory or empirical evidence; there is no reason to expect that regardless of the source of inflation, the best response is to increase interest rates. One hopes that most countries will have the good sense not to implement inflation targeting; my sympathies go to the unfortunate citizens of those that do. … The struggle to meet rising food and energy prices is hard enough. The weaker economy and higher unemployment that inflation targeting brings won't have much effect on inflation – it will only make the task of surviving in these conditions more difficult." (Business Day May 8 2008)
• Gerald Epstein, Professor of Economics, University of Massachusetts: “Empirical evidence of countries that adopted inflation targeting shows that domestic monetary policy has not reduced inflation, and that the promised gains in employment have, generally, not materialized; and, for many countries following this orthodox approach, economic growth has not significantly increased. Countries with inflation targeting have experienced slower economic growth and lower employment growth, without succeeding in lowering inflation at a smaller economic cost than traditional methods of inflation fighting. Clearly, it is time to find an alternative to inflation targeting” (Epstein 2003).

• Bernanke, et. al, 1999 – a review of the literature shows that inflation targeting does not appear to increase the credibility of central bank policy and therefore, does not appear to reduce the sacrifice ratio related to monetary policy (i.e., there is as much negative impact on growth and jobs as is caused by normal inflation fighting monetary policy that does not use a target).

• Otmar Issing, a board member of the European Central Bank says: “Visible success in the management of monetary policy is not only confined to inflation targeting central banks. There is no unique or best way of monetary policy making and different approaches or frameworks can lead to successful policies by adapting better to diverse institutional, economic and social environments.”[3]

• Bruno and Easterly (1996) supported by Epstein (2000, 2002) show that “there is growing evidence that moderate rates of inflation, inflation up to 20% or more, has no predictable negative consequences on the real economy: it is not associated with slower growth, reduced investment, less foreign direct investment, or any other important real variable that one can find.”

The question is not whether we aim for such levels of ‘moderate’ inflation, but whether we are prepared to tolerate and manage these levels (including stopping inflation from spiralling to unacceptably high inflation levels), in the context of an aggressive drive to meet our developmental targets. Therefore the jibes of those (including in our Treasury) who suggest we are somehow supporting a Zimbabwe hyperinflation route of complete mismanagement, must be dismissed as a red herring. We, on the other hand, need to point out that rigid application of the inflation targeting model in South Africa (and elsewhere) has totally failed to achieve its target, using the blunt instruments of interest rates, because as Stiglitz has pointed out, of the ineffectiveness of this instrument, and the impact of external factors. At the same time, the disaster of inflation targeting mismanagement has exacted huge costs, in terms of loss of employment, growth, repossession of peoples property etc

In the South African context, inflation targeting effectively replaced the Gear targets , which targeted a number of macro-economic variables (including the deficit, employment etc). The inflation target therefore became the central economic target, holding the rest of economic policies hostage. In the international context, as well as in South Africa, inflation targeting has had a strong ideological dimension, and has been the key weapon of neo-liberal ideologues to discipline governments from adopting expansionary policies.

Inflation targeting internationally was put in place to reduce the sovereignty of government and reduce the role of the state. Inflation targeting allows markets to discipline governments that spend ‘too much’ and 'pursue populist social spending'. It assures financial markets that government will secure their interests, at the cost of the productive sector. While inflation targeting is ‘aimed at attracting foreign investment’, in most developing countries this means the ability to keep attracting short-term speculative, destabilising capital inflows, not foreign direct investment.

Developed countries, while preaching this gospel to developing countries, do not subject themselves to this pressure eg the USA follows monetary policies which are not subject to inflation targeting, inter alia because its currency is less vulnerable. Other developing countries which do not practice inflation targeting, including China, have put in place measures to protect their currency from speculators. Therefore the debate around inflation targeting is closely related to issues of inequality in the global financial regime.

It is no accident that our fiscal, industrial and other policies, have become hostage to the inflation targeting regime, even where, on the face of it, they have adopted contradictory goals to monetary policy. So, for example, the development of a state-led interventionist industrial strategy, has been effectively frustrated by the high interest rate regime which has stifled investment in the productive sector. Similarly, stated commitment to a more expansionary fiscal stance, was rapidly eroded by the tyranny of inflation targeting, the country being told that we had to run a budget surplus to contain inflationary pressures in the economy.

The advocates of inflation targeting have resorted to the simplistic, and misleading arguments that inflation targeting is in the interests of the poor because inflation hurts them most (ignoring the cost to the poor of pursuing these targets, and the benefits to the rich of a low inflation regime); and that inflation targeting is necessary to avoid hyperinflation of the type we have seen in Zimbabwe.

Contrary to the line put out in the media, a high interest rate and low inflation regime is in the interest of rentier groups, and the financial sector, not the poor and the old.

The issue is not the impact of inflation per se, on the poor, but, rather, the destructive impact of monetary policy designed to reduce the rate of inflation and to keep it low, compared with the impact of monetary policy designed to generate more employment or more rapid economic growth.

To many people the argument that high inflation hurts the poor appears to be common sense[4]. After all who would wish for the value of their currency to be eroded? But the real question that has to be asked is what is the price paid by the poor and society as a whole, for pursuing low inflation policies; and who are the major beneficiaries of these policies. Clearly no-one benefits from hyperinflation of hundreds or thousands of percent. But who is hurt and who benefits from moderate inflation of 10-20%?

In a low inflation, high interest rate regime (despite low growth in the real economy) it is the financial sector and speculative investors who benefit most, leading to growing levels of inequality in society, as they are able to multiply the value of their investments. Conversely, there is evidence internationally that the income share of the lower deciles is positively related to moderate inflation levels- ie poorer groups tend to get a higher share of income when inflation is higher, and vice versa. This may be counter-intuitive, particularly given the propaganda we are daily bombarded with, but that doesn’t make it any less real. Recent experience in South Africa suggests that low inflation has coincided with rising income inequality.

At the same time, the impact of low inflation on the poor depends on various factors - the nature of the inflation (e.g. the rates of inflation of goods consumed by different income categories; the relationship between inflation and unemployment; etc). If therefore, there is a trade-off, even if it is only partial, between low inflation, and growth and employment (a trade-off that becomes starker at lower rates of inflation), why put low inflation first as a target and other objectives as just broad policy goals? Of course we don't want hyperinflation, but we need to distinguish between guarding against hyperinflation, and subordinating our economic policy to a inflation targeting regime.

The question is not: would you like to achieve the objectives of high growth, high employment, elimination of poverty and inequality, and at the same time maintain low inflation. This is a utopian vision in a capitalist society, which is not supported by reality. The question is rather are these priority developmental objectives of a society such as South Africa, compatible with a rigid commitment to low inflation, enforced by high interest rates: the evidence suggests not- rather a scientific analysis of economic development clearly indicates the opposite: rising standards of living, redistribution of wealth, reduction in unemployment etc all raise the level of demand, and create inflationary pressures in the economy.

Countries that have invested, grown and created jobs over a relatively long period have had to do so in an environment where inflation is increasing because growth, investment and employment all put upward pressure on inflation. Rising nominal price levels often induce increased supply, more jobs and even more investment. The success of countries such as S. Korea and Japan was that they could increase productivity during these periods.

Having inflation targets means that any potential of a prolonged period of economic growth (which is not due to debt driven consumption), investment and job creation led by the productive sector will be stillborn because inflation will quickly move outside of the target range (due to domestic factors, leaving aside for the moment the question of external shocks).

Society therefore, in simple terms, has the choice to accommodate a moderate level of inflation (and to use a range of instruments to contain it at that level, to avoid high inflation); or to suppress growth and development to meet the objective of a low inflation rate. There is unfortunately, a clear trade-off, even if the trade-off is a complex one.

Another weakness of the central banks' singular focus on inflation levels is that they do not consider important factors that increase macroeconomic instability: “An important cause of financial crises is not consumer price inflation, but asset price inflation, or bubbles (particularly in stock and property markets). The threat to macroeconomic stability is not only financial crises and contagion from crises elsewhere, but volatility and uncertainty in the economy owing to financial instability.”

“This volatility caused by rapid, uncontrolled changes in the level of liquidity in the economy stifles investment and job creation. It encourages short-term speculation in financial markets rather than long-term investments in building the productive and skills base of an economy. It can lead to an overvalued exchange rate that makes foreign borrowing and imports cheaper and, in turn, leads to financial fragility in the form of higher levels of foreign debt and a large trade deficit.” (Seeraj Mohamed polity.org.za 23 May 2008)

The burden of proof is on the advocates of inflation targeting to illustrate the benefits for a developing country. Research has shown that it does not result in a reduction of inflation or inflation expectations. Instead it results in lower output and employment and a permanent deflationary bias in monetary policy.

Way Forward

There are a range of issues which need to be debated by the Alliance, in order to develop an appropriate monetary policy. These can be clustered into four areas:

• The goals of monetary policy, and its relationship to economic policy as a whole
• Mechanisms to co-ordinate monetary policy, and the role of the Reserve Bank
• Alternative instruments to advance a developmental monetary policy
• Processes to develop an Alliance agreement on monetary policy

1. The goals of monetary policy, and its relationship to economic policy as a whole

There needs to be a proper debate in the Alliance about the goals of monetary policy and the Reserve Bank, and the weight that the Reserve Bank should place on each macro-economic objective, including growth, employment and inflation. It is clear that a public commitment to only one of these targets- inflation targeting- will not allow the dynamism in monetary policy, required to meet the overall developmental objectives of society. When faced with particular challenges, the imperatives of certain areas of policy, such as growth, may need to subordinate the inflation objectives eg now in the face of a looming recession.

It is significant that a number of international central banks reduced interest rates recently to deal with the international economic crisis, despite the inflationary pressures. Our bank not only kept rates stable last week, but actually stated that they never even considered the possibility of a rate cut!

If employment is at the centre of macro-economic policy the target for employment should take precedence. There should be consideration of numerical targets for GDP growth, employment, investment, income distribution and the exchange rate. There needs to be consideration given to establishing a hierarchy of targets, with one overriding objective, such as employment.

One of the objectives of macro-economic policy, and economic planning, is to promote a high degree of stability and co-ordination between different areas of policy. It has been argued that inflation volatility is more damaging to the economy than a high rate of inflation per se.[5] In SA, the volatility of inflation increased after the implementation of Gear, primarily due to increased volatility of the rand following capital account liberalization, which played havoc with key macro-economic indicators. Clearly, volatility of the rand, high interest rates, combined with a high current account deficit, is a recipe for instability. Monetary policy needs to promote greater economic stability, through the use of a whole toolkit of instruments.

One of the problems in current debates it that there is too much separation between macro and micro policy without understanding the interaction of each. For example, it is sometimes claimed that macro economic policies have ‘achieved stability’, and we now only need the successful implementation of micro economic policies such as industrial policy. What this fails to understand is that inappropriate macro-economic policies have actually frustrated the implementation of industrial policy. We not only have to get the micro policies correct and understand the micro foundations of macroeconomic policy, but also the macro foundations of micro policy.

At the level of macro economic policies, too an appropriate relationship needs to be sought between the key elements. In particular fiscal policy, under an inflation targeting regime, is forced to become subservient to monetary policy, and becomes overly concerned with reducing the fiscal deficit which is seen as inflationary. A developmental monetary and fiscal policy need to reinforce each other’s goals.

Monetary policy needs to be correctly located as a tool of the development state's programme of economic transformation, rather than as the dominant component of 
the macro framework. This perspective allows for the envisaged planning centre to 
align monetary policy and inflation objectives with the overall development agenda, rather than this being a narrow technocratic function of the Bank and Treasury.

2. Mechanisms to co-ordinate monetary policy, the mandate and role of the Reserve Bank

Goal and instrument independence of the Reserve Bank

We need to distinguish between Goal and instrument independence of the Reserve Bank, vis a vis the role of government in determining monetary policy. Goal in/dependence describes the bank’s role in determining the policy objectives of monetary policy. Instrument in/dependence describes its role in determining the instruments / daily management of monetary policy, which it uses to achieve the agreed objectives.

Many people are of the view that our Bank is problematically independent, both in relation to its goals, and its instruments. But actually, the setting of a clear inflation target by government, without the prescription of any other targets (employment, growth) clearly determines and actually dictates the objectives which the Bank has to pursue. On the face of it therefore, it doesn’t have ‘goal independence’.

It must be remembered that when inflation targeting was initially proposed, this was opposed by Tito Mbowen, who was already Governor, on various grounds. However, once Treasury determined the inflation target (and Treasury has been given that power), the Governor became the most ardent enforcer of the target. It should of course be accepted that the Bank, in any event, was predisposed to implementing a low inflation target, formally or informally. The previous Governor, Chris Stals, is believe to have targeted a de facto range of between 1-5%.

So the issue is whether the goal which is set by government, is in line with governments overall development objectives ie ensuring that monetary policy is aligned with, and doesn’t contradict those overall goals. This needs to be set by government as a whole, in line with its political mandate, and not just by Treasury.

Secondly, while it may be necessary for the Bank to have a degree of operational autonomy in its day to day management of monetary policy (and there is a continuum internationally, with no banks having complete independence from the government), government also has a key role to play in determining the overall strategy of the bank, including the instruments used to achieve the countries monetary policy and macroeconomic goals. This includes determining a toolkit of measures, such as differential interest rates, measures to regulate the financial sector etc.- see below. Therefore it is argued that no Bank can have complete independence either in relation to its goals or instruments, while accepting for obvious reasons that there needs to be avoidance of over-interference in the daily workings of the Bank. Conversely, if the Bank strays from its strategic mandate and agreed objectives, government has a duty to intervene.

A question which arises is whether our Constitutional provisions and legislation promote a developmental agenda, both in terms of the relationship of the Bank to government, as well as in relation to the objectives identified therein. The relevant sections of the Constitution are reproduced below, and those clauses dealing with the object of the Bank, and its relationship to government, are highlighted. There needs to be consideration, given our experience over the last 14 years, whether these clauses, as well as the Act, now needs review, and in particular whether the mandate of the Reserve Bank, should be broadened to include employment:

224. Primary object

1. “The primary object of the South African Reserve Bank is to protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic. 

2. The South African Reserve Bank, in pursuit of its primary object, must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the Bank and the Cabinet member responsible for national financial matters.”

225. Powers and functions

“The powers and functions of the South African Reserve Bank…must be determined by an Act of Parliament and must be exercised or performed subject to the conditions prescribed in terms of that Act.”

Accountability of the Bank and Inflation targeting

University of Massachusetts’ Gerald Epstein quotes advocates of inflation targeting as claiming that inflation targeting is associated with more central bank independence, and at the same time, more accountability. He then asks: “If the central bank becomes independent, then it would seem that it would be accountable to nobody but itself. How then can advocates of inflation targeting then claim that along with independence comes accountability? Inflation targeting and central bank independence makes the central bank less accountable to the government and more accountable to the financial markets. The elevation of inflation targets over all other goals of policy seems to reflect more the power and influence of rentier interests than a sober approach based on the needs of the economy.”

Galbraith says: “Inflation targeting reduces the accountability of central banks by allowing them to avoid responsibility for the impact of their policies on the performance of the economy in terms of economic growth and employment. Inflation targeting in all cases coincided with high unemployment, and its main effect was to excuse central bankers from addressing the crisis.” [6]

The SA Reserve Bank is immune from accountability for its role in contributing to macroeconomic instability, low investment levels and increasing unemployment, because it is only answerable to its single target, and is politically quarantined by its constitutionally guaranteed independence. It is therefore able to maintain its focus on inflation without considering economic growth, jobs and the effects of changing liquidity on the economy. The Alliance needs to consider what mechanisms are necessary to call the relevant authorities to account on these important economic matters.

Both the mandate and structure of the Reserve Bank needs to be reviewed. Its monetary policy committee should be expanded to include a range of stakeholders from civil society. The need to co-ordinate fiscal and monetary policies to achieve growth and employment targets implies that the Reserve Bank should not be independent and operate in a vacuum where it is not accountable to anyone, but itself. We need to look at international case studies which demonstrate the value of close co-ordination. The Chinese central bank, for example, is not independent, but is an integral part of the country’s growth strategy.[7]

3. Alternative instruments to advance a developmental monetary policy

Current monetary policy revolves around two problematic elements: use of interest rates as a blunt instrument to achieve a rigid inflation target, despite the inability of this crude mechanism to impact on external factors; and the reliance on high interest rates to maintain short term capital inflows. We need to develop a monetary policy, and Reserve Bank, which uses multiple tools to combat excessive inflation, while promoting employment and growth, as part of a new mandate. Instruments which have been used successfully internationally need to be carefully considered, and applied to deal with our challenges. These include: the use of differential interest rates- high rates to deter certain economic activity, and low rates to promote investment, employment, low-cost housing etc. ; the introduction of higher reserve requirements for the banks, to curb excessive credit; and active management of the exchange rate to pursue our industrial and other strategies, curbing imports, and promoting local production and exports, a strategy successfully used by various developing countries. Our real interest rates need to be reduced to the same level, or lower, than our trading partners.

At the same time, targeted strategies are required, as a complement to monetary strategy to deal with inflationary pressures which can’t be dealt with by the Reserve Bank alone. These include measures to act against monopolistic import parity pricing in sectors such as fuel, steel, and agriculture. Coherent strategies are needed to lower food and fuel costs, through agrarian reform, competition policy, and other interventions. And strategies to lower the cost of administered prices of public goods, particularly for working people and poor communities.

Unlike the recent boom driven by excessive credit and conspicuous consumption, which is unsustainable; an increase in living standards for the majority of our people, although this would introduce different types of inflationary pressures, could be offset by the economic benefits of rising productivity of the economy, measures to contain food inflation (which constitutes the bulk of poor peoples spending), the economic injection to local communities, and the fact that the increased spending of the poor will to a greater degree be on basic commodities, which are more likely to be locally produced, and labour intensive (than imported luxury commodities). This type of consumption is more sustainable, promotes development and employment, and is less vulnerable to the boom/bust cycle, fuelled by excessive credit.

Particular measures are required to deal with increased speculative short-term capital inflows that induce asset price bubbles and rising access of credit to the affluent. We can deal with this type of inflation by limiting access to credit used for 2nd homes, and consumption by the affluent. Many 'market-based' instruments such as increased reserve requirements on lending, may be used. We also have to put in place measures to curb the bubbles in stock markets.

4. Processes to develop an Alliance agreement on monetary policy

There is currently a wide divergence of views within the Alliance, and between the Alliance and government, about what constitutes an appropriate monetary policy strategy. Further, contrary to the notion that there is a ‘one size fits all’ approach to monetary policy, the international experience shows that this policy arena is highly contested, including the notion of inflation targeting. Rather than attempting to forge a false consensus, or reaching a superficial Alliance agreement, which is ignored by government and the monetary authorities, there is a need for a serious process of engagement, within the Alliance, and society more broadly.

We propose the need for an Alliance-led process to seriously consider the range of monetary policy options available to us, and determine which options will best advance the developmental goals which the Alliance has adopted at Polokwane. This requires that we go beyond the single option menu which has hitherto been presented by Treasury. An open engagement requires that we look at all monetary policy options which will “support and sustain growth, job creation and poverty eradication on a sustainable basis” (Polokwane economic transformation resolution).

A serious policy engagement in the Alliance requires the setting up of a dedicated Alliance team, with the support of progressive experts, to :

• Examine monetary policy options implemented internationally, and their success in advancing developmental objectives;
• As a disciplined force of the left, we need engagement with the views of progressive economists on these matters, to assist us in engaging the policy options;
• Undertake an engagement with Treasury and the Reserve bank, and other relevant institutions in government;
• Open up an engagement on the issues in broader civil society and in Nedlac;
• Make recommendations to the Alliance constitutional structures

In particular the Alliance team would need to propose:

• What policy shifts are required to advance our developmental goals;
• What legislative amendments need to be put in place;
• What institutional arrangements, including reform of the Reserve Bank structures, and its relationship to government, are required.

The work of this team needs to be completed before the new term of government in 2009, and processing of decisions on its recommendations incorporated into the five year programme of the next government. It is important that the formulation in the Elections Manifesto on the issue of monetary policy captures this commitment to adjusting monetary policy to meeting our developmental goals, and does not pre-empt a proper consideration of the options. Therefore, in particular, the Manifesto should not commit itself on inflation targeting, since the Alliance will not realistically have been able to properly complete this process by the time the Manifesto is finalised.

The Failure of Inflation Targeting - Joseph E. Stiglitz

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Footnotes:

[1] See box below on critiques of inflation targeting. Even a 2003 paper of the IMF found that there was no evidence that inflation targeting improves economic performance as measured by inflation, output or interest rates. Laurence Ball and Niamh Sheridan (2003) “Does Inflation Targeting Matter”

[2] In fact Joseph Stiglitz, cites evidence showing that it is only when countries cross the threshold of 40% annual inflation that they fall into a high inflation, low growth trap.

[3] Comments made at a Panel Discussion on inflation targeting at the Federal Reserve Bank of St Louis, 17 October 2003.

[4] However Stiglitz cites evidence showing that it is only when countries cross the threshold of 40% annual inflation that they fall into a high inflation, low growth trap.

[5] Jeremy Wakeford (2003) “Monetary and Exchange Rate Policy in SA,” in Nicoli Nattrass, Jeremy Wakeford and Samson Muradzikwa (eds) (2003) Macro-Economics: Theory and Policy in SA.

[6] Foreign Affairs (1999) “The Inflation Obsession: Flying in the Face of Facts.”

[7] Duma Gqubule “SA under Gear”

ENDS