High inflation hurts people and economies. In South Africa, we need to be having conversations about our target range, and whether it needs to be adjusted downwards in time
18 April 2024 - 06:00
bySimon Brown
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Inflation targeting is an entrenched part of central bankers’ lives. In the US and Europe it’s 2%, while, locally, we have a 3%-6% target range, with the Reserve Bank governor always referring to the midpoint of 4.5%.
But the concept of inflation targets is relatively new and the science behind it nonexistent.
Inflation targeting was introduced in New Zealand in December 1989 with a target of 0%-2% by December 1992 (the country’s inflation was more than 7% at the time). Canada followed in 1991, the UK in 1992, and Sweden, Australia and Finland in 1993.
The US Federal Reserve introduced inflation targeting only in 2012, with some tweaks in 2020, while the European Central Bank introduced a 2% target in 2021, adjusting its previous policy of maintaining price stability.
South Africa’s inflation target was introduced in February 2000.
Reserve Bank governor Lesetja Kganyago. Picture: FREDDY MAVUNDA/BUSINESS DAY
Speaking to experts, I expected to hear dense theoretical reasons for the target range. However, there is no hard data or science behind it. Rather, the target range seems to have been selected because it is high enough to avoid deflation, and low enough to avoid the kind of rampant inflation that can hurt economies and populations.
The point is that even though there is no real science behind the targets, they do serve a purpose. First and foremost, inflation targeting sets inflation expectations. If people believe the central bank and trust its ability to keep inflation largely at the target, then they start to accept inflation at around that target over the longer term. Salary increase requests will generally be in line with the target and consumer goods producers that try to push prices higher than inflation targets will be shunned.
The target also adds transparency to the inner workings of the central banks while also giving businesses and consumers an important ability to anticipate interest rate changes.
This then brings me to South Africa’s inflation target and Bank governor Lesetja Kganyago, who has a few times over the years commented that a lower target is desirable. The point is, how and when do we change that target?
If we were to drop our current target right now to, say, 3%, we’d be in a heap of pain. Inflation is at the upper end of the range, with the monetary policy committee not expecting it back at 4.5% until the end of next year. So a new 3% target would at best mean no rate cuts until late 2025 or even early 2026.
Still, this is a conversation we should be having so that one day, when our inflation is at, say, 3.5%, we can switch to a new target of 3%. Let’s get talking so we’re ready, because the debate will be heated; parliament could even step in with a law that would trigger a reduction on our inflation target once a certain inflation point is reached.
Ultimately, a lower target is good for everybody as it means lower inflation and hence a lower rate of our wealth and money being eroded.
Support our award-winning journalism. The Premium package (digital only) is R30 for the first month and thereafter you pay R129 p/m now ad-free for all subscribers.
SIMON BROWN: Let’s talk about inflation
High inflation hurts people and economies. In South Africa, we need to be having conversations about our target range, and whether it needs to be adjusted downwards in time
Inflation targeting is an entrenched part of central bankers’ lives. In the US and Europe it’s 2%, while, locally, we have a 3%-6% target range, with the Reserve Bank governor always referring to the midpoint of 4.5%.
But the concept of inflation targets is relatively new and the science behind it nonexistent.
Inflation targeting was introduced in New Zealand in December 1989 with a target of 0%-2% by December 1992 (the country’s inflation was more than 7% at the time). Canada followed in 1991, the UK in 1992, and Sweden, Australia and Finland in 1993.
The US Federal Reserve introduced inflation targeting only in 2012, with some tweaks in 2020, while the European Central Bank introduced a 2% target in 2021, adjusting its previous policy of maintaining price stability.
South Africa’s inflation target was introduced in February 2000.
Speaking to experts, I expected to hear dense theoretical reasons for the target range. However, there is no hard data or science behind it. Rather, the target range seems to have been selected because it is high enough to avoid deflation, and low enough to avoid the kind of rampant inflation that can hurt economies and populations.
The point is that even though there is no real science behind the targets, they do serve a purpose. First and foremost, inflation targeting sets inflation expectations. If people believe the central bank and trust its ability to keep inflation largely at the target, then they start to accept inflation at around that target over the longer term. Salary increase requests will generally be in line with the target and consumer goods producers that try to push prices higher than inflation targets will be shunned.
The target also adds transparency to the inner workings of the central banks while also giving businesses and consumers an important ability to anticipate interest rate changes.
This then brings me to South Africa’s inflation target and Bank governor Lesetja Kganyago, who has a few times over the years commented that a lower target is desirable. The point is, how and when do we change that target?
If we were to drop our current target right now to, say, 3%, we’d be in a heap of pain. Inflation is at the upper end of the range, with the monetary policy committee not expecting it back at 4.5% until the end of next year. So a new 3% target would at best mean no rate cuts until late 2025 or even early 2026.
Still, this is a conversation we should be having so that one day, when our inflation is at, say, 3.5%, we can switch to a new target of 3%. Let’s get talking so we’re ready, because the debate will be heated; parliament could even step in with a law that would trigger a reduction on our inflation target once a certain inflation point is reached.
Ultimately, a lower target is good for everybody as it means lower inflation and hence a lower rate of our wealth and money being eroded.
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