Will we be agonising, 20 years from now, over how we lost control of inflation?
Good afternoon, ladies and gentlemen.For two decades, we have been part of a great international experiment in getting monetary policy right. Inflation targeting has delivered a long period of price stability, comparable to the best years of the post-War Bretton Woods system, and should be considered a success for SA and for many other countries.
How easily could we have made the same mistakes! We could have said that — with high unemployment, and such great economic demands after apartheid — it was just not possible to control inflation. And then we would have ended up with no social benefits — no more growth, no extra jobs — but with high and stubborn inflation instead, just as it did for Burns.
Today, there is a new generation coming of age, in very difficult circumstances. They have many questions — about the economy in general, and about how monetary policy fits into the picture. Some of the questions are asked in a fiery tone, and I think that young people are right to be angry. Not only have they been unlucky, reaching adulthood during one of the worst economic disasters in modern history.
While we would all like SA to reach permanently high growth, this is beyond the powers of a central bank. As we have often communicated, most of our growth problems should be addressed through structural reforms and confidence-boosting measures. To give just one example, the central bank cannot stop electricity load-shedding with interest rates.
Would it make sense to add growth or employment to the mandate of the SARB, alongside the price stability mandate? Our labour markets have also historically raised the cost of hiring people even when the economy is weak and people are losing jobs. This cost inflation has further undermined job creation even when growth picks up.
There’s no doubt that global factors affect inflation. Globalisation and low-cost manufacturing have made many goods cheaper. The recent collapse in oil prices has been a big disinflationary shock. The third argument is that inflation targeting is a rich-country policy, inappropriate for an emerging market like SA. In fact, inflation targeting has been adopted widely by emerging markets. This makes sense, as many of us have learnt from bitter experience that tolerating inflation isn’t developmental — it just creates instability.
Nonetheless, should deflation take root, we would be prepared to deploy the tools at our disposal, as appropriate, to achieve our mandate. Our inflation-targeting framework would help us make that decision, and would underpin the credibility of any steps we might need to take. Should the SARB start doing QE, however, by buying bonds on the secondary market, then investors could shift risk back onto the public sector’s balance sheet, at a higher price. In other words, it would be a private sector bailout, arranged by the SARB. Worse, QE would reduce the incentives for new investors to come and buy long-term sovereign debt, because there would not be enough yield or compensation for the longer-term risks now visible.
Putting all the pieces together, this monetary-fiscal mix allows more spending in the context of a major emergency. We are helping by setting low interest rates, and by ensuring that the government bond market remains liquid. National Treasury is able to sell its debt to investors. This approach is going to deliver a historically high level of government spending this year, even adjusting for population growth and inflation, and excluding interest costs.
As Mervyn King has noted, all previous monetary policy paradigms have fallen, sooner or later. The current one will also be replaced, eventually, by one that works better for future circumstances. What might change?
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