South Africa’s ‘made up’ inflation target

Lesetja Kganyago

Genera Capital’s Dr Adrian Saville said there is no hard science behind inflation targeting, but it does have benefits in setting inflation expectations.

Inflation targeting is a framework in which a central bank uses monetary policy tools, especially controlling short-term interest rates, to keep inflation in line with a given target. 

The South African Reserve Bank has set South Africa’s inflation target as a range of 3% to 6%, with an ideal of keeping inflation anchored around the mid-point of this range (4.5%).

While there is evidence pointing to the fact that lower inflation is better for a country’s economy, while higher inflation can compromise economic growth, no exact numbers will work for every country, Saville said.

He told MoneywebNow that “inflation targeting, for all intents and purposes, is a made-up number”. 

“It was a target that was made up sort of off the cuff on the spur of the moment saying, ‘Wouldn’t this be a good idea?’ It wasn’t initiated with empirical backing.”

He explained that it is generally accepted that a range of low inflation, like 2.5% to 5%, is a sensible target. 

In addition, “once you start creeping into higher single-digit inflation, you start to give up economic growth”. 

“Once you’re into double digits, there is unquestionably a strong negative relationship with inflation, employment and economic growth.”

“So the relationship exists. The precision or the preciseness with which those targets are presented – that is more sort of rainbow or mythical in its construct.”

In addition, he emphasised that inflation relationships shift over time and are also different across countries.

For example, below is an overview of different inflation targets for different countries, courtesy of the International Monetary Fund.

However, Saville said a point that shouldn’t be lost is that the inflation target creates an expectation and certainty among citizens and investors, which can be good for an economy.

Broadly, a central bank has two tools to manage inflation – interest rates and inflation expectations.

Both tools are relatively blunt, but inflation expectations are forward-looking, while interest rates are a lagging instrument.

“So you only know how effective your blunt instrument has been with the benefit of hindsight,” Saville explained.

“The one thing that you want is an absolutely level-headed, steady-eyed central banker who tells you what the ambition is – and that is what inflation targeting does.”

“Having said all of that, the 3% to 6% admittedly is a wide range, which is why our central bankers have got into the practice or habit of pointing to the middle of that range.”

Earlier this year, SARB Governor Lesetja Kganyago said the Reserve Bank is considering lowering South Africa’s inflation target.

Speaking at the Peterson Institute for International Economics in April, Kganyago said a lower target of around 3% would benefit fiscal policy and stronger growth.

“A lower target, sitting at 3%, would help dampen exchange rate volatility and sovereign risk, reduce the potential for upward drift in the real exchange rate, and materially lower debt service costs, primarily for the now over-indebted public sector,” he said.


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