The Reserve Bank in Pretoria. Picture: FINANCIAL MAIL
The Reserve Bank in Pretoria. Picture: FINANCIAL MAIL

History credits former UK prime minister Winston Churchill with the famous words “never let a good crisis go to waste”. The implication is that a crisis presents an opportunity to do things that would otherwise not be possible.

These words might provide the context for an assessment of the current monetary policy stance of the SA Reserve Bank. Is the Bank applying this principle in the grip of the Covid-19 crisis?

The Reserve Bank was established a century ago, in 1921. Since then SA has suffered two brief periods of deflation (after the initial inflation pressures at the end of World War 1 and during the Great Depression of the 1930s). The country also suffered sustained and rapid price increases for two decades in the 1970s and 1980s during the great inflation of our time.

Under the capable leadership of Chris Stals as its governor in the 1990s, the Reserve Bank refocused on combating inflation. This was a success, with a much lower inflation rate at the end of that decade than in 1990.

One important result of the Reserve Bank’s policy focus in the 1990s was a change in inflation expectations. After 20 years of sustained high inflation the view by the end of the 1980s was that SA “will always suffer from high inflation”, especially after a level of nearly 20% a year was reached by 1986. On the contrary, it was clear by 1999 that high inflation does not have to be a permanent feature of the SA economy.

After the success of the 1990s it was time for a new policy framework to ensure inflation remained under control. SA therefore adopted a policy framework of inflation targeting. This could be implemented because inflation expectations were contained in the 1990s compared to the 1970s and 1980s. Containing inflation expectations is a cornerstone of successful policy of inflation targeting.

SA adopted an inflation target range of 3%-6% a year. Despite the commitment of the Reserve Bank to this inflation target range, the inflation rate initially showed large swings, breaking the target range at the upper and lower limits. However, increased stability in the inflation rate within the range was achieved in the decade after 2010.

Under the able leadership of the current governor, Lesetja Kganyago, the Reserve Bank started emphasising since 2017 this stability in the inflation rate by focusing on the midpoint of the target range — 4,5%. The objective is to reduce inflation expectations to 4,5% from the previous level of 6%.

At the outset of the Covid-19 crisis the Reserve Bank dropped the repo rate on more than one occasion. This drop was justified by low inflation and a decline in inflation expectations. These rate declines were aligned with the focus on the midpoint of the inflation target rate. Nevertheless, since the monetary policy actions of the Bank at the outset of the crisis, there is mounting pressure for further monetary policy easing. As the Bank has not heeded these calls, Churchill’s famous words come to mind.

The question is whether the Reserve Bank decided to use the Covid-19 crisis to quietly introduce an inflation target focus of 3% — the lower level of the inflation target range rather than 4,5%. If this is indeed the case, something good will come for SA from the Covid-19 crisis: sustained permanent lower inflation. However, this will initially imply higher interest rates to contain inflation and inflation expectations at about 3% a year.

Once inflation and expectations settle permanently around that level lower interest rates will follow. This will ease the interest burden on government borrowing and boost domestic investment, thus supporting more rapid economic recovery and growth as well as job creation.

• Rossouw is a professor at Wits Business School.

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