Inflation targeting has helped stabilise the South African economy

There have been important gains in the conduct and performance of monetary policy in South Africa over the last decade. Inflation targeting, introduced in 2000, and supported by fiscal restraint, has contributed to the much improved macro-economic stability in South Africa.

Research from the University of Oxford, UK, reviews the design and performance of monetary policy in South Africa between 1994 and 2004. Monetary policy in South Africa is directed to achieving price stability and providing a framework for balanced and sustainable economic growth. Monetary policy (including the setting of interest rates) enables governments to control the amount of money in the economy to achieve desired outcomes, such as higher growth or lower inflation.  

The research compares the monetary policies of two central bank governors: Stals and his successor, Mboweni. Under Stals, policy was opaque, and excessive interest rate volatility (which is a measure of financial risk) due to exchange rate crises damaged economic growth and people’s confidence.

In 2000, under Mboweni’s governorship, South Africa became the first country in Africa to adopt inflation targeting - a policy popular in many developed countries from the 1990s. Inflation targeting is used to help control inflation and makes transparency in policy formulation vital. This involves the government setting the central bank a target range within which inflation must fall. Inflation and output are then forecast and interest rates are used to bring future inflation in line with the target.

The research finds that since South Africa introduced inflation targeting, monetary policy has performed well. Key indicators on growth, inflation and interest rates have improved. This success is particularly noteworthy as the economy has suffered large disruptions, such as the sudden fall in the value of the currency in 2001, over this period.

The research finds that since the introduction of inflation targeting in 2000:

• Inflation has fallen and stabilised.
• The transparency and accountability of the central bank’s decision-making have improved.
• The credibility of monetary policy has increased as inflationary expectations of trade unions, business and financial analysts have converged on the target rate.
• Monetary policy is more predictable and market traders and analysts make reasonable forecasts of interest rates.
• Monetary policy decisions taken in response to economic disturbances, such as a fall in the currency value, have improved.
• The real domestic tax-adjusted cost of borrowing to companies is internationally competitive.
• Lower economic uncertainty and more stable inflation and interest rates have supported investment and growth.

Monetary policy is only one of a range of policy tools that governments use to achieve their economic objectives. Monetary policy in South Africa faces current dilemmas by the strong growth of demand and of asset prices, and the lack of good quality data is a constraint. The authors conclude that monetary policy needs to be supported and accompanied by a number of other policies:

• Better statistical data, for example on earnings and prices, is needed – particularly to improve the forecasting models used for inflation targeting.
• Financial policies, such as property and land taxes could help contain rising debt-to-income ratios, driven by rising house and land prices and which promote consumption.
• Financial regulation and better information for borrowers could help longer-term debt contracts to be extended, rather than having floating-interest rate debts that are vulnerable to interest rate fluctuations.
• Basing monetary policy on a single price index that excludes mortgage interest costs and bases homeowners’ costs on estimated rents, would be simpler (for example in wage settlements) and more effective and cheaper.

Source(s):
‘A Review of Monetary Policy in South Africa: 1994-2004.’ Special issue of the Journal of African Economies on South African Economic Policy under Democracy: a 10 year review, by Janine Aron and John Muellbauer, forthcoming, 2007
‘Transparency, Credibility and Predictability of Monetary Policy in South Africa.’ Mimeo, Centre for the Study of African Economies, Oxford, by Janine Aron and John Muellbauer, 2007
‘Review of Monetary Policy in South Africa since 1994’, CSAE Working Paper 2006-07, by Janine Aron and John Muellbauer, 2006 (PDF) Full document.

Funded by: UK Department for International Development

id21 Research Highlight: 12 June 2007

Further Information:
Janine Aron
Centre for the Study of African Economies
University of Oxford
Department of Economics
Manor Road
Oxford OX1 3UQ
UK

Tel: +44 (0)1865 271084
Fax: +44 (0)1865 281447
Contact the contributor: janine.aron@economics.ox.ac.uk

Centre for the Study of African Economies, University of Oxford

John Muellbauer
Nuffield College
University of Oxford
New Road
Oxford OX1 1NF
UK

Tel: +44 (0)1865 278583
Fax: +44 (0)1865 278621
Contact the contributor: john.muellbauer@nuffield.ox.ac.uk

Nuffield College, University of Oxford

Other related links:
Further details about this research project 'Monetary policy, growth and stability in Sub-Saharan Africa'

"Has financial liberalisation brought economic growth for southern Africa?"

Alternatives to Inflation Targeting Monetary Policy For Stable and Egalitarian Growth: A Brief Research Summary: Paper presented at World Institute for Development Economic Research (WIDER) Jubilee Conference, Finland, 2005 (PDF)

Asymmetries in the Effects of Monetary Policy: The Case of South Africa, University of Otago > Economics Discussion Papers, New Zealand (PDF)

Monetary Policy Transparency and Financial Market Forecasts in South Africa, IMF Working Paper (PDF)

Inflation and Output Forecasting for South Africa: Monetary Transmission Implications, Paper from the Centre for the Study of African Economies, University of Oxford (PDF)