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.


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.

3 thoughts on “Inflation targeting – the lovely discourse

  1. Not sure if this little story I received by email is entirely relevant to your post, but thought you might appreciate it anyway:

    Another day dawns over a small tourist village on the shores of the Black Sea. It is raining, and the little town looks totally deserted. It is tough times, everybody is in debt, and everybody lives on credit.

    Suddenly, a rich tourist comes to town.
    He enters the only hotel, lays a 100 Euro note on the reception counter, and goes to inspect the rooms upstairs in order to pick one.

    The hotel proprietor takes the 100 Euro note and runs to pay his debt to the butcher.

    The Butcher takes the 100 Euro note, and runs to pay his debt to the pig grower.

    The pig grower takes the 100 Euro note, and runs to pay his debt to the supplier of his feed and fuel.

    The supplier of feed and fuel takes the 100 Euro note and runs to pay his debt to the town prostitute that in these hard times, gave her service on credit.

    The hooker runs to the hotel, and pays off her debt with the 100 Euro note to the hotel proprietor to pay for the rooms that she rented when she brought her clients there.

    The hotel proprietor then lays the 100 Euro note back on the counter so that the rich tourist will not suspect anything.

    At that moment, the rich tourist comes down after inspecting the rooms, and takes his 100 Euro note, after saying that he did not like any of the rooms, and leaves town.

    No one earned anything.

    However, the whole town is now without debt, and looks to the future with a lot of optimism.

    1. I also am not sure if it is relevant, but it is a good story – and says something important about the circulation of money …. I am just not sure what it is.

  2. Inflation targeting was ill-suited for South Africa right from the start. With 25% of the workforce excluded from the global market for labout, IT put a plaster cast on a broken leg before first realigning the bone. The result? We have a permanent limp – high employment – which can only be overcome by 5m tax payers now subsidizing 13m grant recipients. This is little more that guilt money being paid by the “I’m alright First Economy” to the “Sorry you will never get a job” Second Economy.

    And now we learn from the retiring Bank of England MPC member, David Blanchflower, that IT never worked in the developed world either.

    We have walked – as we do too often – in the dreams of a foreigner only to find out that it ended up being a nightmare for them too!

    Wake up, South Africa! We need a monetary policy that works for our Second Economy, not merely Mr and Mrs Aston-Martin!

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