Inflation targeting – the lovely discourse

You might not be aware of it, but there is “a lovely discourse” about inflation targeting going on.

These were the gentle, if slightly quaint, words of Pravin Gordhan as part of an expression of  support for SARB governor Tito Mboweni yesterday (June 23).

This comes after months of Cosatu’s blustering against inflation targeting: threatening to call a strike against high interest rates, marching against the SARB and criticising Mboweni, including calling for his contract not to be renewed for a 3rd term in August.

The debate is important, and it is difficult not to wish that Cosatu was less  threatening and bombastic and that the SARB and the Department of Finance spent a little more time explaining themselves in lay person’s terms. In the spirit of supporting the “lovely discourse” I hereby summarise (probably simplistically) what could have been, in a better world, opening statements from the two sides of the debate:

Cosatu’s view – if it bothered to explain itself

The SARB’s targeting of inflation means interest rates are too high. This means “borrowing” and debt is expensive. This hurts us and our members because they have household and personal debt. But more importantly, companies throughout the economy struggle to grow when interest rates are too high – they can’t borrow money for capital expenditure and their customers have less money to buy the goods produced; this means downward pressure on wages and employment. Lowering interest rates sets off a virtuous cycle: companies grow, employment increases, more money is available for consumption which in turn drives economic growth. Tax income improves which drives government expenditure which in turn continues to fund consumption and GDP growth and employment. And there’s an additional bonus: reduced rates reduces the attractiveness (to foreigners) of holding our currency, and this devaluing affects means the cost of production is  reduced – when stated in foreign currency terms – making international trade more profitable. So for Cosatu this is a virtuous circle that constantly and ever more deeply stimulates the traded goods sector. If the SARB was given “employment” or “GDP growth” as its target instead  “inflation” it wouldn’t feel compelled to hike interest rates and thereby kill growth.

The official view – if it were easier to understand

This view is almost exactly opposite to Cosatu’s. The first point of departure is that “the official view” is not, primarily, the view of the SARB. It is the view of the government that mandates the SARB i.e. that mandates the SARB to target inflation – as opposed to any other objective – with the only weapon in it’s arsenal: the ability to determine the rate at which money is lent and borrowed.

 (Note: does this mean government doesn’t care about growth? Of course not. But just because an objective is desirable doesn’t mean it is sensible to decree that a certain instrument will henceforth achieve that objective: People are hungry? Henceforth the department of Science and Technology will provide one chicken for every family, once a week! Yaaay! … government has solved the hunger problem -not.)

The official view is about understanding the  limits of what is possible  i.e. monetary policy can only use one instrument (interest rates) to target one objective (inflation). Aside from being the only achievable objective, a low, stable inflation rate is a necessary – although not sufficient – condition for sustainable growth.  To understand the benefits of this conservative approach examine the implicit critique of the alternative: artificially lowering interest rates creates an economy-wide equivalent of a sugar buzz in small children: stimulation, yes; but a short-term rush with unhappy long term consequences. With Cosatu’s proposed growth stimulated by “cheap money” (i.e. radically reduced interest rates) there are no efficiency gains – in management, productivity, pricing and the effective use of technology. Growth that comes about by “artificially lowered interest rates” – i.e. growth in a high inflationary environment –  creates the kinds of businesses that have no inherent strengths and no inherent need to be competitive. So yes, wages and employment go up, but those gains are only held while the artificial conditions (conditions created purely by government or central bank – or Cosatu – decree) continue. The official view emphasises the desirability of inflation targeting for an additional reason: high inflation directly and immediately worsens the conditions of life of the poorest and most vulnerable South Africans. The rich can, at least partially, protect themselves from the effect of inflation by investing in financial instruments such as inflation linked bonds.

Conclusion

This is Pravin’s “beautiful dialogue”, and I’m hoping that wiser heads than mine can help draw out the issues more clearly. My instincts (honed by Cosatu’s refusal to explain itself and instead to constantly threaten to strike)  is to suspect Cosatu of being sectarian and short-term; and to think of government as nobly attempting to meet its manifold obligations and responsibilities, including to the poorest South Africans. I am prepared to accept that I am giving government too much credit and Cosatu too little – and generally missing the point in the “lovely discourse” going on around inflation targeting.