Inflation Targeting under Fire: The South African Finance Department and Reserve Bank Are Facing Fresh Criticism about the Economic Harm Being Done in the Region by Forcing the Economy into Punishing Inflation Brackets. Tom Nevin Weighs Up the Issues

Article excerpt

The South African Reserve Bank (SARB) has entered 2010 as though treading on glass, fearful of upsetting the fragile balance that is keeping inflation more or less within the targeted range of 3% to 6%.

Coerced by the recession and a severe interest rate, inflation entered its desired bracketing in the dying months of 2009, prompting calls from hard-pressed consumers for pre-Christmas relief from the 10.5% bank rate. The SARB, however, declined and has held its repo rate firm. The hamstrung business regime has resulted in credit demand seeing its sharpest annual contraction in 43 years, reflecting weak consumer spending, mounting job losses and tight bank lending.

Even more worryingly, the straitjacketed economy has delivered a tax revenue shortfall of R26bn ($3.8bn) to the end of November 2009, prompting finance minister Pravin Gord-han to predict a Rzobn ($10bn) under collection for the year, compared with 2008/09. The trend would translate to a R184bn ($26bn) shortfall for 2010/11, or a budget deficit of 9% of GDP. The biggest losses came in corporate and value added tax.

The SARB's credit figures show that the local economy remains brittle, with consumer spending falling for the fifth consecutive quarter. Nedbank chief economist Dennis Dykes says high unemployment and debt levels, along with weak confidence, continue to offset improving affordability in the household sector while companies cut back on investment and expansion plans. Dykes says some relief could arrive with the cash income surge of the soccer World Cup and if interest rates are cut to stimulate employment.

SARB's inflexibility in adjusting interest rates and in focusing on inflation targeting has been confirmed by new governor, Gill Marcus, who says that a low and steady inflation rate is its key mandate from the Department of Finance and that the interest rate is the most effective means of keeping it there.


Analysts' opinion holds that the most counterproductive effect of inflation targeting is the hardening of the rand with harmful knock-on to the mining industry, tourism, exports and manufacturing.

The business community is largely adjusting its views on the value, and even the need, for inflation targeting, while the most rigid of all its supporters, former governor Titus Mboweni, appeared to have changed his mind just prior to his departure, suggesting it might be time to revisit the drawing board.

Progenitors' second thoughts

The architects of inflation targeting, New Zealand, are also having second thoughts about the relevancy, or even wisdom, of trying to tame their economy by making it jump through the hoops of what the central bank, summarily, thinks inflation should be. It is not only New Zealand that is having doubts. Such strongly developing countries as Argentina, Brazil, the Philippines and Turkey are also questioning the wisdom of whether entire economies must be held ransom to inflation targets.

Some suggest the practice is a cop-out and an easy and convenient way for central bank chiefs to confront a sticky problem. It precludes the creative solutions that would arise if central bank management seriously tackled the problem in other ways, such as exchange rate targeting, employment creation or macro economic flexibility.

Increasingly, economists are questioning whether developing economies should be growth-strangled, because a monetary policy like inflation targeting is the fashion flavour of the times, and not of proven beneficial substance. According to Gerald Epstein, professor of economics at Massachusetts University, a wide array of central banks have adopted inflation targeting as their "only mandate".

While the practice might seem plausible for mature economies, it makes little sense for those, such as South Africa's, struggling to find a foothold as they ascend into the global economic community. …