ANDILE NTINGI: Time to reconsider SA’s inflation targeting model

When a 64km-long convoy of Russian military vehicles was threatening to storm Ukraine’s capital Kyiv in early March, I told my wife I was praying for the war between the two eastern European neighbours to come to an end quickly. Kyiv, located in central Ukraine, did not fall, but fighting has since moved to the eastern part of the country, where it is raging with no end in sight.

When I brought up that discussion my wife wondered why I cared so much about a conflict happening 14,500km from Johannesburg. I told her the sanctions Russia was being slapped with by Western countries for invading its neighbour could lead to a sharp spike in energy and food prices.

This is because the sanctions would lead to the disruption of global energy and food supply chains, as Russia was a major exporter of gas and crude oil, which it supplies cheaply to Europe through a network of pipelines. Furthermore, Russia and Ukraine are considered the breadbasket region of Europe thanks to their large production of oil seeds and wheat, which they export to the rest of the world.

Two months after we discussed the Russian invasion of Ukraine my wife came back from the supermarket shocked by a significant spike in food prices, particularly that of cooking oil. Around the same time the rise in petrol and diesel prices had started biting hard, pointing to a potential increase in factory gate costs and consumer inflation.

We came to the realisation that we must brace ourselves for a barrage of interest rate hikes by the SA Reserve Bank as it attempts to quell rising inflation. In fact, what is happening now is that the skyrocketing cost of living and cost of credit are crushing SA’s middle class and low-income earners.

In the case of the Reserve Bank, its monetary policy actions are guided by the inflation targeting doctrine, which was introduced 22 years ago as a tool to keep consumer inflation within a target range of 3%-6%. The problem with inflation targeting is that it is a blunt instrument that pulverises consumers and small businesses with high interest rates regardless of the factors that are driving inflation up.

For example, the Bank hiked the repo rate by 50 basis points to 4.75% last month, arguing that it expected higher global oil and food prices to push consumer inflation to about 5.9% this year. In May consumer inflation hit 6.5%, breaching the upper limit of the inflation target, from 5.9% in April.  

The Bank has projected that fuel prices will be 31.2% higher this year, while local food price inflation for a basket of goods is expected to be 6.6%.

British magazine The Economist has estimated that due to the war the number of people globally who are not getting enough food has risen by 440-million to 1.6-billion. Nearly 250-million are at risk of famine.

Since November last year the Reserve Bank has raised interest rates four times, the last two after the war in Ukraine broke out. This raises this question: if inflation is driven up by exogenous factors that have nothing to do with consumers engaging in excessive consumption or borrowing, why is the central bank punishing them? It is the war in Ukraine that has set inflation alight, not overzealous SA consumers or borrowers.

Punishing borrowers will trigger a spike in house and car repossessions. It could also lead to business closures and job losses as both consumers and companies struggle to pay their creditors. In this instance, inflation targeting can be counterproductive if it hampers economic growth. For the economy to grow and create jobs it needs consumers that spend and businesses that invest.

Maybe the time has come to reconsider the inflation-targeting model, which I believe is inappropriate for an emerging market, developing country like SA with her world record unemployment rate and debt-ridden consumers. At very least the upper bound of the target range must be revised upwards by at least two percentage points to 8%. The current target range of 3%-6% is unrealistic and probably more appropriate for developed, First World economies.

Hiking interest rates aggressively at a time when the SA economy is still recovering from the Covid-19 pandemic is also ill-advised. Earlier this month the World Bank cut its global growth forecast by 1.2 points to 2.9% and warned that the war in Ukraine could plunge low- and middle-income economies into stagflation — a toxic concoction of recession, rising inflation and high unemployment.

SA is considered a middle-income economy, and if the World Bank is correct with its prediction this means the 1.9% GDP growth we registered in the first quarter of 2022 could be reversed by stagflation.

In the 1970s the global economy experienced stagnation when an oil shock (caused by disruptions to Middle East oil production) led to a slump in global economic growth and rampant inflation. In those days recessions were cured by Keynesian fiscal stimulus interventions, whereby governments increased public works spending to boost aggregate demand. Essentially, public spending was used to bolster household spending, which then stimulated production.

However, Keynesian policies, pioneered by British economist John Maynard Keynes, was not designed to treat the stagflation experienced in the 1970s. That is, until Canadian-American economist Robert Mundell, a proponent of supply-side economics, suggested that stagflation could be cured by cutting taxes instead of increasing public spending. Mundell believed stagflation was caused by low aggregate supply, not depressed aggregate demand. He suggested if governments cut taxes consumers and businesses would respond by spending and investing more, thereby stimulating production (availability of goods and services), which would then lower prices while boosting employment.

When former US president Ronald Reagan moved into the White House in 1981 he immediately implemented Mundell’s tax cuts. This policy, known as Reaganomics, led to the disappearance of stagflation. I believe SA policymakers should focus on implementing policies that boost investment and production. Our economy is being held back by low aggregate supply, not aggregate demand. High interest rates, electricity cuts, rising fuel prices, water shortages, poor infrastructure, endemic corruption and investment-deterring legislation and polices are responsible for holding back our economy.

Pursuing a less aggressive inflation-targeting policy might be the first step in avoiding both recession and stagflation.

• Ntingi is founder of GetBiz.