Reserve Bank must avoid short road to inflationary oblivion
Given the bluntness of the SA Reserve Bank’s instruments, it is far better to address the structural shortcomings of the economy directly
To say that all is not well with the SA economy is an understatement. First-quarter economic growth came in at -3.2% and unemployment is in excess of 27%. Fiscal policy is unsustainable and state-owned enterprises (SOEs), especially Eskom and SAA, see mounting debts in addition to mounting management and operational troubles.
For ANC secretary-general to announce in the midst of all that the intention of the governing party to change the Reserve Bank’s mandate and use the money press to relieve government’s debt pressures, just added oil to the already high-burning fires of uncertainty.
To call for the Reserve Bank to have a dual mandate, like the US Fed has, that focuses on both economic growth and price stability, ignores the fact that, in a sense, the Reserve Bank already has a dual mandate. Article 224 of the constitution says “The primary object of the SA Reserve Bank is to protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic.”
Instead of a blunt statement that just says the Reserve Bank should pursue both, the constitution demonstrates a careful understanding of the link between the value of the currency (price stability) and economic growth. In essence, it says that balanced and sustainable growth is only possible with price stability.
However, price stability does not guarantee economic growth. Growth also requires the right infrastructure, skills and know-how, the lack of which, among other things, explains SA’s low growth. Although a central bank can directly target economic growth, its instruments are very blunt. It can decrease interest rates and increase liquidity in the banking sector in the hope that banks will extend more loans to boost the demand for goods and services.
However, boosting demand without an increase in the capacity of the economy to produce more and increase the supply of goods and services, only leads to higher prices. Expanded supply is not only a function of the cost of credit. Much more important is whether there is enough investor confidence in the economy to invest in production capacity that will expand supply. SA lacks investor confidence and the policy uncertainty we experience is not helping.
Furthermore, if boosting demand and supply leads to higher prices, the Reserve Bank will be failing to meet its constitutional obligation to maintain price stability — and as many historic episodes show us, attempts to stimulate growth through money creation often lead to much higher inflation and even episodes of hyperinflation. Inflation erodes the purchasing power of incomes, especially those of the poor who do not have the option to hedge their income against inflation.
Given the bluntness of the Reserve Bank’s instruments, it is far better to address the structural shortcomings of the economy directly. Thus, a trade and industry policy with subsidies focused on specific industries (as used in the automotive industry), or an energy policy that creates the right environment for independent power producers, is better targeted and effective. For such targeted policies the government can use a development bank, but that is a completely different kind of institution from a central bank.
Magashule’s statement seems to imply that the Reserve Bank should buy out intergovernmental debts using quantitative easing. This was a policy used by the US Federal Reserve (Fed) and other central banks to stabilise global financial markets in the aftermath of the global financial crisis of 2007/2008.
In essence, it is not that different from what central banks do every day, but ramped up to deal with an acute financial market crisis. In normal times, central banks, including the SA Reserve Bank, influence short-term interest rates by setting the repo rate. A repo transaction occurs when a bank sells a short-term instrument, such as a treasury bill, to the Reserve Bank at a discount to the value at which the bank will buy it back from the Bank at a later stage. That discount, expressed as a percentage per annum of the price at which the bank sells the instrument to the Reserve Bank, is the repo rate.
With quantitative easing, more or less the same thing happens, the difference being that the instruments used are long-term instruments such as mortgage-back securities.
After the global financial crisis in 2007/2008, the Fed reduced the Fed funds rate to almost 0% and yet it was unable to stimulate the US economy. In an effort to spur borrowing, the Fed subsequently used quantitative easing to also lower long-term interest rates. Thus, quantitative easing is not the buying of intergovernmental debts (which presumably includes state-owned enterprise debt), as Magashule’s statement suggests.
During the 2007/2008 financial crisis, the US government, not the Fed, bought bad debts from banks using its Troubled Asset Relief Programme (Tarp). But Tarp is not quantitative easing: Tarp used tax revenue to buy the bad debts, not newly printed central bank money.
Moreover, Tarp was a much smaller programme than quantitative easing, and constituted no more than 2% of US GDP, whereas SOE debt in SA is closer to 20%.
The Reserve Bank's buying intergovernmental debts would just be old-fashioned monetisation of government debt, which, as the recent experiences of Zimbabwe and Venezuela showed, is a short road to inflationary oblivion. Merely monetising the SOE debt does not address the underlying problems that gave rise to their unsustainable debt levels. Fixing these problems will require hard business decisions and trade-offs, and the longer we wait, the harder these decisions and trade-offs become.
• Burger is professor of economics at the University of the Free State.