RAYMOND PARSONS: The delicate art of monetary policy in uncertain times

Monetary policymaking needs complex real-time judgements, as the latest Reserve Bank monetary policy review again confirms. At what level to set interest rates, when to change them and how monetary policy fits into the broader economic landscape demand the highest degree of professionalism and expertise in any economy.

This is more so when there is elevated economic uncertainty. In SA we are fortunate to have an experienced and respected central bank that enjoys strong credibility for the authoritative economic assessments on which it eventually bases its vital interest rate decisions.

However, that does not mean there may not often be differences of opinion about particular interest rate decisions — even within the monetary policy committee (MPC) itself — in interpreting the relevant economic data and assessing the balance of risks. The monetary policy review also refers to the existence from time to time of split decisions by the MPC.

When looking at the same economic data there is legitimate scope for divergent views about the “right” level of interest rates at any one time. The monetary policy review highlights several special factors recently shaping the data-driven scenario that the MPC usually mobilises.

For two months in a row (February and March) the headline inflation rate has stubbornly refused to fall as much as analysts had expected and is now still up at 7.1%. Food prices have been identified as the main culprit. Economists nevertheless felt that though the overall inflation rate seemed “sticky”, the rate of food inflation would, for various reasons, be likely to fall in the second half of 2023.

The producer price index eased in March. And the monetary policy review sees both headline and core rates of inflation moderating in the future. Yet objectively the rate of headline inflation at 7.1% remains well above the Bank’s target range of 3%-6%.

Several analysts in any event had already pencilled in a further rise of 25 basis points (bps) at the next MPC meeting even on their previously expected lower consumer price index (CPI) rate. Commentators have therefore taken the view that the latest inflation figures may compel the Bank to maintain an even more hawkish stance at its next meeting on May 25 because of its lingering concern about inflationary expectations and possible “second round” effects.

This must, of course, now also be seen against a background in which the Bank has already raised borrowing costs by a cumulative 425bps since its interest rate raising cycle started in November 2021. The repo rate is now at its highest since 2010.

But recently the story has helpfully shifted from one of inflation seeming to rise ever higher to one of failing to come down as quickly as expected. This is still not a comfortable place, but at least reflects a degree of progress.

In assessing the economic data available to it, and in deciding on future interest rates, the MPC will nevertheless now need to also carefully assess the cumulative lag effect on the real economy of previous interest rate hikes. These usually take 12-18 months to reveal their total effect.

We can see that building plan statistics, for example, are now showing a sharp declining trend, partly due to higher borrowing costs for households and businesses. The monetary policy review also confirms that “the full impact of the cumulative rate hikes is yet to be felt”.

Complicating the economic outlook and data interpretation are also the negative effects of the Eskom rolling blackouts on growth and inflation in recent months. The monetary policy review has now offered estimates of these costs.

Widespread concern is mounting about the further negative economic and business effect of Eskom’s present high level of load-shedding. It has raised the risk that the economy may now have moved into a technical recession — that is, two successive quarters of negative growth.

With 1.3% GDP contraction in the fourth quarter of 2022 and a series of mainly negative high-frequency data in the first quarter of 2023, the recent Nedbank Guide to the Economy has also warned that “the chances of slipping into technical recession are high”.

This confirms the recent weak growth forecasts for 2023 as a whole by, for example, the IMF (0.1%), the Reserve Bank (0.2%), Fitch (0.2%) and Nedbank (0.2%). Neither the monetary policy review nor the MPC’s March statement made any reference to recession risks. The latter saw the risks to the growth outlook then as “balanced”.

Even today management of the repo rate cannot, unhappily, be entirely based on exact science or economic modelling. Judgement is required to interpret economic trends that cannot be exactly measured, even with valuable guidance from the Bank’s updated Quarterly Projection Model. Monetary policy cannot be reduced to mechanistic rules of thumb, even if we had exact daily figures for everything in theory we require to know.

Empirical and theoretical research published in the SA Journal of Economics in September 2018 concluded that “uncertainty shocks are particularly pernicious for inflation-targeting central banks in that they have stagflation effects”.

Can an analogy now perhaps be drawn with the Bank’s response to the Covid-19 pandemic a couple of years ago? In the face of the devastating damage done to economic activity by the official lockdowns, the Bank promptly and substantially cut interest rates to assist the economy.

A persuasive case can be made that the drastic Eskom rolling blackouts constitute a similar adverse shock to output and costs, with concomitant economic dislocation. Given the present high inflation, though, it is not a question of cutting interest rates at this stage, but rather of examining options in the present circumstances.

The options could be a rise of 50bps, 25bps or a pause in raising interest rates. “I always ask myself the question,” former US Federal Reserve chair Alan Greenspan once said, “what are the costs if we are wrong? If there is no downside risk you can try any policy you want. But if the cost of failure is large, you should avoid the policy.”

The monetary policy review itself describes GDP growth in SA as “fragile”. Downside risks have now been injected into SA’s economic performance that urge caution in deciding the next step in the interest rate cycle.

The dynamics of prevailing economic uncertainties therefore suggest that the MPC will now need to take a fresh look at the contours of the economic outlook and be alive to the new emerging risks to that outlook.

There needs to be robust debate, both inside and outside the Bank, about the appropriate path of monetary policy in the months ahead. There are whirlpools on both sides, not on one only.

• Parsons is a professor at the North-West University Business School.