Reserve Bank governor Gill Marcus has rejected the view that monetary policy could be used as a tool to solve the unemployment crisis in South Africa, hitting back at economist Joseph Stiglitz’s criticism of the 3%-6% inflation target, saying it remained relevant.
She also rejected the argument that tighter monetary policy undermined export competitiveness, saying on Thursday that “there are a number of factors currently impacting the exchange rate, and it is not only an interest rate story”.
Most monetary policies around the world are aimed at a low inflation environment, but the jury is out on whether targeting has been a success in the face of persistent economic shocks, and economic debate continues to rage about how much flexibility should be allowed around a target if economic conditions worsen. It is also unclear if it is the ideal policy for volatile emerging economies. South Africa’s economy, which grew at less than 2% last year, was recently hit with a 50-basis-points increase in rates as a weak rand combined with inflationary pressures to scare the central bank.
Mr Stiglitz said on Wednesday the challenge for countries using inflation targeting was striking a balance between managing inflation and supporting job creation.
Ms Marcus said while unemployment was a structural problem, the central bank was still “sensitive” to the effect of monetary policy on economic cycles. “For this reason our policy rate has been slightly negative for some time, and remains negative notwithstanding the recent interest rate increase, and – remains accommodative. However, monetary policy cannot solve what is essentially a structural unemployment problem in the country.”
Ms Marcus said that when the economy was growing at rates in excess of 5% in the mid-2000s, the unemployment rate declined only to about 22%, compared with the current level of just over 24%.
She said Bank policy allowed for temporary breaches of the target. “However, in such instances, we have to be mindful of the trade-off between such flexibility, and the impact on monetary policy credibility and inflation expectations.”
Apart from controlling inflation, the central bank also operates under an explicit financial stability mandate, as it needs to ensure that asset price bubbles do not build up. South Africa’s control of its banking sector was broadly lauded during the 2008-9 financial crisis, for ensuring the banking sector did not blow out, as it did in many other countries.
Mr Stiglitz has been one of the foremost critics of inflation targets for a while. Sanlam chief economist Jac Laubscher said on Thursday that while his criticism was nothing new, he was “right that at times the Bank’s stance could address cyclical unemployment”.
Mr Stiglitz said that in trying to contain inflation, the “cure would be worse than the disease” and “inflation targeting is being put to the test – and it will almost certainly fail”.
Mr Laubscher said the Bank could be more open in its guidance to the market.
“For instance, if you hike rates, how far will this transmission mechanism go to make inflation lower?”
There is a view in the markets now that the central bank has become more tolerant of high inflation. But Ms Marcus said on Thursday that the Bank did not target the upper end of the target, which has experienced temporary breaches over the years. “We would prefer to be more comfortably within the target band, but there are times when achieving the mid-point could require an excessively strong monetary policy response.”
Mr Stiglitz questioned the effectiveness of higher interest rates in curbing inflation, especially if the causes of inflation were external factors such as higher food and oil prices.
Ms Marcus said temporary breaches of the target were consistent with the flexible framework as this helped to avoid volatility in interest rates. The breach this year, with consumer inflation predicted to rise to 6.6% from the present 5.8%, is expected to be short-lived. “We are confident it will be reversed within a short period.”