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 ofmonetary policy in South Africa between 1994 and 2004. Monetary policy in South Africa is directed toachieving price stability and providing a framework for balanced and sustainable economic growth. Monetarypolicy (including the setting of interest rates) enables governments to controlthe amount of money in the economy to achieve desired outcomes, such as highergrowth or lower inflation.  

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

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

The research finds that sinceSouthAfricaintroduced inflation targeting, monetary policy has performed well. Keyindicators on growth, inflation and interest rates have improved. This successis particularly noteworthy as the economy has suffered large disruptions, suchas the sudden fall in the value of the currency in2001, over this period.

The research finds that sincethe introduction of inflation targeting in 2000:

• Inflation has fallen and stabilised.
• The transparency and accountability of the centralbank’s decision-making have improved.
• The credibility of monetary policy has increasedas inflationary expectations of trade unions, business and financialanalysts have converged on the target rate.
• Monetary policy is more predictable and markettraders and analysts make reasonable forecasts of interest rates.
• Monetary policy decisions taken in response to economicdisturbances, such as a fall in the currency value, have improved.
• The real domestic tax-adjusted cost of borrowingto companies is internationally competitive.
• Lower economic uncertainty and more stableinflation and interest rates have supported investment and growth.

Monetary policy is only one ofa 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 demandand of asset prices, and the lack of good quality data is a constraint. The authorsconclude that monetary policy needs to be supported and accompanied by a numberof other policies:

• Better statistical data, for example on earningsand prices, is needed – particularly to improve the forecasting modelsused for inflation targeting.
• Financial policies, such as property and landtaxes could help contain risingdebt-to-income ratios, driven by rising house and land prices and which promoteconsumption.
• Financial regulation and better information forborrowers could help longer-term debt contracts to be extended, ratherthan having floating-interest rate debts that are vulnerable to interestrate fluctuations.
• Basing monetary policy on a single price indexthat excludes mortgage interest costs and bases homeowners’ costs on estimatedrents, would be simpler (for example in wage settlements) and moreeffective and cheaper.