Inflation Targeting: Panel discussion

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Finance Standing Committee

19 September 2002
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FINANCE PORTFOLIO COMMITTEE
20 September 2002
INFLATION TARGETING: PANEL DISCUSSION

Chairperson: Ms B Hogan (ANC)

Relevant documents:
Stan du Plessis - Perspectives on inflation targeting after a difficult year: Briefing
Gordon Smith - It pays to Keep the (Inflation Targeting) Faith: Briefing
Azar Jammine - Inflation and Inflation Targeting: Briefing

SUMMARY
Stan du Plessis of the Department of Economics, Stellenbosch University; Dr Azar Jammine, Director and Chief Economist, Econometrix (Pty) Ltd and Mr. Gordon Smith of Deutsche Bank briefed the committee on inflation targeting.

There is consensus from all three briefings that the current inflation level is to blame on the same global and local factors that caused the slide of the Rand. They clearly expressed their support of the SARB's monetary policy.

They support inflation targeting fully and also support the rise in interest rates as the only sensible instrument to combat inflation.

MINUTES
Perspectives on inflation targeting after a difficult year: Briefing by Stan du Plessis of the Department of Economics, Stellenbosch University.
Mr Du Plessis added a few general comments to his presentation. He made it clear that our current inflation is moderate and far from being out of control as some sectors of the media and public have made it out to be. He did concede that it is higher than what South Africans would want.

He emphasised that it is possible for developing countries to have low inflation rates and gave examples. He warned that unrealistic forecasts and targeting can break down the credibility of policymaking of the SARB (South African Reserve Bank).

Inflation & Inflation Targeting: Briefing by Dr Azar Jammine, Director and Chief Economist, Econometrix
Dr Jammine emphasised that the current inflationary problems were not caused by the SARB, but rather by other external factors. He blamed the rise in inflation on the factors that led to the dramatic depreciation of the Rand last year. He mentioned the rise in food prices and the municipal taxes and rates hike as major factors.

Dr Jammine said it was very important that we look at the fall of the Rand instead of looking for problems within the current monetary policy. He also forecast that inflation would drop next year as the Rand has stabilised over the last year.

He advocated retaining current targets to show the government's commitment. He also feels very strongly that lending rates must be kept higher than inflation at all time. Dr Jammine said that it is the responsibility of the government to raise the expectations of the public, especially after the levels of afro-pessimism reached alarmingly high levels at the end of 2001.

It pays to Keep the (Inflation Targeting) Faith: Briefing by Mr Gordon Smith of Deutsche Bank
See document for input.

Discussion
Mr Moloto (ANC) referred to Dr Jammine's suggestion that inflation be measured excluding food, housing and vehicle running costs (CPI) and asked what the relevance of that inflation figure would be?

Dr Jammine answered that the CPI would be a better tool for combating inflation. Mr Smith, later in the discussion, disagreed with this opinion. He felt the all inclusive CPIX is a better indicator of real terms. Mr Du Plessis echoed Mr Smith's sentiments.

Mr Nene (ANC) asked what other tools there are for controlling inflation except for interest rates.

Dr Jammine replied that there are two other options. Firstly the SARB could implement an exchange rate policy to control the value of the Rand. This has previously been shown to stifle export performance and would not be a desirable option. Secondly the government could introduce price controls which all three presenters agreed would be a terrible idea. That would be a move to hide inflation.

Mr Smith added that it is the National Treasury that set the inflation target.

Dr Rabie (NNP) asked whether any of the emerging world markets have used the CPI to measure inflation.

Dr Jammine said that he was not aware of any and that we should guard against using other countries' models.

Ms Taljaard (DP) said that it is clear to her that there was insufficient discussion on this topic before they had started with inflation targeting. She then compared the South African situation to that of Brazil and enquired about the relevance of a measure change.

Mr Jammine said that using a point target with a tolerance level, instead of a range, is an option, but if the depreciation of the Rand repeats itself (due to unforeseen global factors), South Africa would have a problem. He added that the rest of the world would understand if South Africa changed its measure.

Mr Du Plessis commented that the South African and Brazilian economies are not that similar and that they have different objectives. He added that he is also in favour of sticking to the current CPIX, which he feels is a true reflection of inflation.

Ms Mahlangu (ANC) enquired of the role of the private sector. She also wanted clarification on the model the SARB uses and what the impact of rising inflation and raised interest rates is on growth.

Dr Jammine answered that the impact will be less disposable income for individuals. He added that the economy is on a surprisingly strong up thanks to improved exports and the improved (during the last 5 years) financial position of companies and individuals. He said that South Africans are in a better position now to withstand the raise in interest rates. He added that increased government spending negates the negative impact of higher interest rates and that this will mean that the economic downturn would not be so severe.

Mr Du Plessis felt that the SARB's policy decisions this year have helped the continued robust performance of the economy. He told the Committee that they do not have access to the SARB's model. On the issue of the role of the private sector he said there is asymmetry in wage setting between the two sectors. Private sector wages do not have a political component to them and therefore focus more on short term factors and will buy into the concept of inflation targeting much easier.

Mr Mnguni (ANC) raised the issue of transparency in SARB, especially access to their model.

Ms Hogan mentioned that the Bank of England publish the minutes of their monetary policy meetings and asked the presenters if they would like to see that in South Africa.

Mr Du Plessis said it would help to get more independent opinions rather than concentrating on getting in-house consensus.

Mr Smith also agreed with Mr Du Plessis and suggested a rotation policy for the Monetary Policy Committee. He felt it would help a lot to get more academic input.

Mr Hanekom (ANC) asked whether the difference between the point and range measure is not mostly psychological. He wondered if the current target is realistic and whether it should not be higher in developing countries. He asked the presenters if there is a trade-off between inflation and growth. Finally he enquired after the interest rate as a tool to combat inflation.

Mr Smith answered that if they move to a midpoint in the range it would make a psychological difference. On the inflation growth trade-off question he said that there are libraries full of books on this subject. More important would be changes in real variables to stimulate real growth. Mr Smith added that increasing interest rates is basically the only tool available to combat inflation.

Mr Du Plessis mentioned the example of Thailand where they had lost 36 Billion $ in 24 hours in 1997 trying to protect their currency. He argued that South Africa does not have the reserves to protect the economy through controlling the exchange rate. He added that there is no evidence of a trade-off between inflation and growth.

Ms Taljaard commented that if one wants to change the target (whichever way), that there are interrelated policy factors that bind inflation and the exchange rate. She asked if South Africans are going to see a second round of inflationary pressures and if so how it could be combatted. She asked the presenters if they have an estimate of the extent of the growth revision.

Mr Smith said it is too early to comment on a possible second round and it would be irresponsible for him to comment before having enough information. He told the committee that Deutsche Bank's estimate for 2003 is ± 3% growth. This figure is based more on global factors than on the question of the sustainability of the Rand.

Mr Lekgora (ANC) wanted clarity on the instruments available to tackle inflation apart from raising interest rates.

Mr Du Plessis said that the interest rate is the correct instrument to use as long as it is done responsibly. Inflation targeting is the correct tool.

Ms Hogan wondered if this was not a broader political issue. She said that society at large has to agree that the current level of inflation is a problem. She was not sure if there is a political buy-in around the inflation issue in society.

Mr Du Plessis added that the current problem is creating awareness on these issues.

Meeting adjourned.

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