MANOEL BITTENCOURT: Macroeconomic theory and monetary policy in SA

The primary objective of the SA Reserve Bank is to protect the value of the rand to achieve economic growth. For that to happen, the Bank, as custodian of the coveted money-printing machine, has been granted operational independence by the constitution, isolating it from political pressures. It implemented inflation-targeting in 2000 as a guide for monetary policy. 

The above embeds concepts from macroeconomic theory that have trickled down to governments and central banks over the past four decades or so. Of importance here is the Lucas critique of policy evaluation, the time inconsistency critique of discretionary policy, and the development of extended dynamic stochastic general equilibrium (DSGE) models. 

The Lucas critique argues that decision rules change when there is a change in the way policy is conducted. Put another way, our decisions depend on our expectations of what policies will be. For instance, the central bank publicly advocates for a lower inflation target to be implemented in the near future and the trade unions form their expectations of wages and their bargaining strategy based on the expectation that the target will be lowered.

Though the central bank is communicating its preference, this is not necessarily a reflection of decisions taken within the government. Though the Reserve Bank is (mostly) independent, it cannot implement policy without the buy-in of the National Treasury. Recall, wage expectations in SA have already formed based on a lower hypothetical target given by the Bank. If this promise cannot be fulfilled or takes longer to materialise than promised, we have time inconsistency between the policy expectations and the policy reality.

To avoid inconsistencies monetary policy is delegated to an independent authority, the central bank, which implements rules such as a well-defined inflation target. In response to the above critiques the DSGE models used by central banks incorporate features such as financial market imperfections, imperfect competition, sticky prices, incomplete markets and other rigidities. These DSGE models imply that credible commitment monetary policy should be conducted so that nominal interest rates and inflation are as low as possible.

Low inflation is an important, desirable outcome. High, higher and hyperinflation affects the poor disproportionately. The poor carry cash; the poor do not have access to financial instruments that offer some protection against inflation; and with high inflation the poor lose employment first because of the macroeconomic uncertainty that affects investment and growth. 

It is encouraging that the Reserve Bank is politically independent and implements inflation targeting. In this case the government and the Bank are following macroeconomic theory and standard institutional arrangements to reduce the critiques above and improve societal welfare. But the IMF is concerned that the Bank lacks transparency and good communication. The fund’s recently released Central Bank Transparency Code review on SA recommends more transparency on what happens behind closed doors, for instance during monetary policy committee (MPC) meetings, and better communication about the target in conversations with the Treasury. 

For well-anchored expectations SA society will benefit from having access to the minutes of the MPC’s meetings, as happens in other countries such as the UK and US. The setting of the target is important. The governor has been arguing in favour of lowering the inflation target, but we don’t know where the Treasury stands on this. Does it have similar policy preferences? The target is set in a process of consultation between the Treasury and the Bank. Better co-ordination and communication between them would make a big difference.

It is gratifying to see macroeconomic theory trickling down to policy, but given human nature there is always the need to improve institutional frameworks and practices so that monetary policy does its job of keeping nominal interest rates and inflation low. Institutions adapt to new realities and in this case it is time for the Bank to adapt its institutional framework.

With more transparency there will be more accountability and credibility and ultimately better economic outcomes through more effective monetary policy.

• Bittencourt is an extraordinary professor of economics at the University of Pretoria.