An address by Lesetja Kganyago,
Governor of the South African Reserve Bank,
at the Centre for Education in Economics (CEEF) Africa
Johannesburg,
28 September 2022
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Reflections of macroeconomic policy since 1995, from NICE to VICE and
back again?
Good evening
Thank you for inviting me to speak today.
This is an unusually challenging moment for the global macroeconomy. Who would
have believed, even a year or two back, that US inflation would be at 8.3%, that euro
area inflation would be at 9.1%, or that UK inflation would be at 9.9%?1 Who would
have thought that major central banks would be raising interest rates at the fastest
pace in a generation? Or that the euro and the British pound would be at parity with
the dollar?
Just over a decade ago, it was common to talk about a Great Moderation in global
macroeconomic conditions. Mervyn King, a former Bank of England Governor, called
it the NICE period: an acronym for Non-Inflationary, Consistently Expansionary.
Today it would be more appropriate to talk about VICE: a Volatile, Inflationary and
Contractionary Economy.
last month's
This regime change in global conditions was reflected at Jackson Hole
Economic Policy Symposium, an annual gathering of central bankers hosted by the
Kansas City Fed of the US Federal Reserve System. The theme of this year's
meeting was 'Reassessing Constraints on the Economy and
Policy'. Given the
humbling economic developments of the past year or so, the tone of the discussion
was very different to that of previous occasions.
No longer were we talking about the challenges of low inflation, or how higher debt
levels are sustainable if interest rates are low, or the social benefits of running
economies hot. Instead, there was a broad appreciation that macro policy settings
had been far too loose in 2021, contributing to high inflation rates and with them, a
cost-of-living crisis.
Russia's war in
Everyone recognised that exogenous shocks, including Ukraine and
supply chain problems, had accelerated inflation.
But expansionary policy settings had left the system highly exposed to these supply
shocks. Just as with supply chains, running the economy hot to achieve slightly
better short-term results came at a high price. The system then failed under stress.
Fortunately, there has been pragmatic recognition of the problems, and a willingness
to change course. At Jackson Hole, Chairman Jerome Powell invoked the legacy of
Paul Volcker, who decisively stabilised inflation after the policy errors of the 1970s.
His point was very clear: the Fed will do what it takes to bring inflation down, and to
keep it down.2
Nobody would choose to play the Paul Volcker role. It would have been much better
if the Fed had not fallen behind the curve, letting inflation get out of control. But now
the course has changed, the approach needs to be about disinflation.
alternative is the route taken by Volcker's
As the Fed well knows, the predecessors,
who did not want to hurt growth.3 Those policymakers made the great mistake, all
too common in macroeconomics, of avoiding the pain of short-term adjustment in the
hope that things would just come right.
Unfortunately, with no one taking responsibility for inflation, firms and households
they couldn't rely on money to keep its value.
learnt that So, they became more
vigilant, quickly raising their own wage and price demands in response to new
inflation pressures. As this inflationary psychology set in, the pain of getting back to
low inflation kept rising. The result was a steadily worse trade-off between the
objectives of full employment and stable prices. For this reason, history and public
Volcker's
opinion have reflected poorly on predecessors.4 By contrast, Volcker is
remembered as a dedicated public servant with a commitment to doing the right
thing, even if it was unpopular.5
Listening to Powell, as a South African I was impressed by the engagement with
history as well as the determination to act on the lessons of historical experience.
South Africa's as the saying goes, history doesn't
Of course, history is different. But
repeat itself, but it often rhymes. Our history too has a theme of macroeconomic
failure, followed by difficult and ultimately successful reforms that built the foundation
for a long boom, followed by decay and the return of the old challenges.
The late 1980s and early 1990s was a period of macroeconomic excess and near
collapse. We achieved stability and growth through reforms conducted from 1994
through to 2009. We now once again find ourselves in profound social and economic
trouble.
Unfortunately, we are struggling to achieve consensus on the proper response to our
current challenges. This weakens our ability to act decisively. Too many people are
unfamiliar with the history of economic policy in South Africa. Worse, those who
know their history cannot seem to agree if the reforms of the late-90s were helpful or
not. In my speech today, I hope to contribute to a better consensus, by revisiting our
own macroeconomic history and highlighting its lessons.
Let me start with the big picture. In the nearly three decades since our transition to
democracy, we have had one Non-Inflationary, Consistently Expansionary, or NICE,
period sandwiched between two bad ones. We can see these phases most clearly in
the growth of GDP per capita, which is the total amount of economic output divided
by population. This measure was negative during the dying years of apartheid, which
means living standards were falling. It turned positive in 1994 and mostly stayed
positive for two decades, apart from the crisis years of 1998 and 2009. From 2014
onwards it has mostly been negative again, with living standards once again in
decline.6
It is tempting to say that this just reflects trends in global growth. But even relative to
the world economy, we have gone from lagging, to outperforming, to lagging once
again. Obviously, world growth fluctuated over this period too. But when we were
doing well, we were pulling ahead, not just keeping up with the world average. And
when we did badly, we slipped behind, as we did before 1994 and as we have done
again in our latest slump.7 Over the past two years our growth rate has been 2.4%
below the global rate, the worst spread since the 1980s.
There are many similarities between the economic conditions of the mid-1990s and
conditions today. Apart from low growth, these also include high and rising
government debt, elevated inflation, and growing unemployment and inequality. In
the 1990s, the new democratic government faced considerable scepticism that it
could turn this around. Critical voices argued that higher debt and inflation were
inevitable and would ultimately provoke a crisis.8 But they were wrong.
To the lasting credit of the democratic government, these challenges did not trigger a
downward spiral. Instead, they inspired a series of reforms that modernised South
Africa's macroeconomic
framework. These reforms steered the country through the
emerging market crises of 1998 and 2001. They then underpinned the longest period
of unbroken growth in South Africa's history. Finally, they created
policy space for
countering the Global Financial Crisis in 2008.
There were three main building blocks to these reforms. One was fiscal restraint,
which allowed debt to stabilise and helped create a virtuous cycle of lower interest
payments, more social and physical investment, and lighter tax burdens. A second
was a floating exchange rate, which liberated the country from costly and
unsuccessful exchange rate interventions and created scope for a more competitive
currency. A third was inflation targeting, which opened the way to lower and more
stable prices and therefore also lower and less volatile interest rates.
These reforms were implemented over a relatively short time span. Although
nowadays South Africa has developed a reputation for being good at planning and
bad at implementation, in this case the whole macro architecture was modernised
within about five years. In turn, this renovation created space for the private sector to
contribute to South Africa's
development.
It also put the public sector in a position of strength, by shoring up the fiscal position
and being realistic about capabilities. The result was that government could succeed
at the tasks it attempted, rather than overextending itself. In other words, the reforms
delivered an overarching framework for making economic policy choices.
Unfortunately, many of these reforms divided people at the time, and despite their
successes, they have remained unpopular in some quarters. For instance, I have
frequently heard it claimed that these policies were undertaken with an ulterior
'neoliberal' attack on an alternative,
motive, as a form of class warfare, a so-called
allegedly progressive or social-democratic alternative.
But these criticisms have never made sense to me.
For a start, I have never understood why anyone confuses practical considerations
with conspiracy theories.
In 1994, the democratic government found a macroeconomy in shambles. A debt
trap loomed, with debt recorded at 60% of GDP.9 The leadership did not want to see
interest payments crowd out their spending goals, and a debt crisis would have
caused serious economic hardship and a loss of policy sovereignty.10
We further recognised the need to alleviate the balance-of-payments constraint. With
low savings, we were in the position that stronger growth necessitated an
unsustainable level of capital inflows. This led to rand weakness, higher interest
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rates and again, slower growth. As a result, the economy could not take off it could
only achieve short periods of growth, and then stall again.
These were real constraints, and the challenge for macroeconomic strategy was to
find ways to deal with them rather than fall into a debt trap, with zero fiscal space,
and no growth. There was no way to deliver social progress without macroeconomic
sustainability.
In addition, despite the language used by the critics, it is difficult to recognise some
neo-liberal model in what South Africa actually did in the 1990s and 2000s. There
was a degree of trade liberalisation, but it was relatively short-lived and not
especially ambitious. Labour market reform was proposed but never implemented.
Some state assets were sold, but privatisation was very limited, leaving a large
portfolio of state-owned enterprises on the public balance sheet, including Eskom
and South African Airways.
The early to mid-1990s featured rapidly rising inflation and collapsing economic
growth. So, for good reason, the South African Reserve Bank (SARB) aimed to lower
inflation. The inflation targeting framework, in addition to providing more flexibility
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than other policy frameworks a point lost on most critics of it when implemented
also featured a high and wide inflation target. Relative to most peers, this proved to
be too flexible, too high and too wide. The result was a tripling of the price level since
2000, the year we adopted inflation targeting. This hardly qualifies as an inflexible
obsession with price stability, nor a framework inappropriate to our growth ambitions.
As for fiscal policy, debt was reduced and there was even a small fiscal surplus in
2006. But again, steering clear of a debt crisis, and later running a fiscal surplus
during the biggest boom in modern history, seem like acts of sanity rather than
ideological excesses. We should also recognise that this period saw significant
increases in social spending. Total transfers to households rose from about 11% of
total spending to 15% during the 2000s, and social benefits increased from under
10% of total spending to 13%.11
If we discard the ideological viewpoint, and look back at this reform period
objectively, how should we assess it? At the time, there was a sense that we had
done many good things, but with underwhelming results. In one of the International
Growth Advisory Panel papers we commissioned back in 2008, for instance, Dani
Rodrik wrote that,
Economic policy has been conducted in an ... exemplary manner, with
South Africa turning itself into one of the emerging markets with the
lowest risk spreads...
If the world were fair, political restraint and
economic rectitude of this magnitude would have produced a booming
South African economy operating at or near full employment.
Unfortunately, it has not turned out that way.12
With the perspective of another decade, maybe that disappointment was overdone.
Certainly, higher growth was desirable. But at least we were growing fast enough to
raise living standards. We were creating jobs. The glass was at least half full.
The main reason we did not get higher growth was probably the failure to match the
macroeconomic progress with equally exemplary microeconomic policies. This point
was made in repeated diagnoses of our economic problems, by a range of top local
and international economists. Sadly, that advice did not translate into further reforms.
Still, these disappointments are minor compared with those of the period since 2009.
We went from having the glass half full to having it nearly empty.
Understanding how this happened is an important first step towards fixing it.
When South Africa's slowdown commenced, shortly after the financial crisis, we did
not at first understand the extent of the problem. Economists generally expected a
rebound in GDP growth, and when it did not occur, the blame was often laid on
temporary factors, such as droughts or strikes. But these explanations were not
enough to explain a decade-long growth decline. As is often the case, it is only with
hindsight that we have been able to put together a more comprehensive analysis.
The most complete study to date is due to a Harvard team, led by Ricardo
Hausmann and Federico Sturzenegger.13 They interrogate three accounts of the
slowdown. One emphasizes global factors, and particularly weaker commodity
prices. The second is about macroeconomic policy, and specifically the possibility
that low growth was due to tight monetary and fiscal policies. The third focuses on
microeconomic effects, chiefly the productivity damage of state capture.
The paper is well worth reading. But let me give away the ending. They largely
dismiss the first two arguments and embrace the third.
Our problem was not the global environment. It was not about fiscal austerity or tight
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monetary policies those were just scapegoat arguments, to deflect blame. It was
about a fundamental deterioration in public sector management, such that the
productive capacity of the country stagnated.
Macroeconomics is often complex and difficult for non-experts to follow, but in this
case the logic doesn't require much explaining. If you borrow huge sums of money to
invest in power stations, but much of the money is stolen so the stations do not work,
and the economy keeps running out of power, then it is hard to grow.14 As the Zondo
Commission of Inquiry into Allegations of State Capture reported, this was not
something happening in the power sector only: it was across the government sector.
And it had profound and lasting consequences.
and 2015's Nenegate
As everyone else in the economy realised what was going on,
was a catalyst here, people changed behavior. For businesses and households,
confidence collapsed.15 Government and state-owned enterprises became
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smothered in debt and ran short of expertise because state capture had prompted
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the departure of many skilled staff the overall result was a sharp fall in investment.
Indeed, in recent years investment has been so low that it has been fully funded from
domestic savings, with spare savings left over to export, giving us a current account
surplus. The balance-of-payments constraint which had shaped macro strategy in
the reform era was no longer binding, simply because the economy stagnated. There
was no confidence for even a temporary boom.
However, if we can start growing again the old constraints will re-emerge. Like it or
not, this means we will need to re-engage with the reform lessons of the 1990s and
take a different approach to policy.
First, we once again face a situation of rising debt and excessive tax burdens. In the
2000s, we generally had revenue a little under 25% of GDP and spending slightly
over 26% of GDP. Now we raise less than 24% of GDP in revenue, despite higher
taxes, and then spend about 29% of GDP.16 This is an unsustainable situation, not
least because the efficiency of government spending has been low.17 Much as I wish
we had a strong state that could deliver high quality public goods at reasonable
prices, the facts reflect otherwise. Relative to the 2000s, we have a weaker state,
spending a larger share of GDP.
The result is an economy barely capable of growth faster than 1%, with a shrinking
tax base and a weak outlook. In these circumstances, trying to deal with social
doesn't really
needs simply through more spending, more debt and higher tax cure
the patient, but rather limits the pain while accepting continued decline. Living
standards cannot rise materially without growth.
The problem goes deeper. If investment did rebound, and government borrowing
continues at around current levels, we would then hit a binding balance-of-payments
constraint. We have had an investment rate of around 14% of GDP recently, against
a savings rate of 15% of GDP.18 A reasonable investment rate would be over 20% of
GDP, and for fast growth probably 30%.19 But given savings levels, this implies
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borrowing between 5% and 15% of GDP from the world very large sums. Current
account deficits of those magnitudes would simply become too unsustainable, if not
impossible, as in the UK currently.
To achieve balanced growth, rather than just recover a boom-bust cycle, we
therefore need better longer-term savings rates. As in the late 1990s, this is going to
require fiscal restraint, as a necessary self-control measure to enable the financing
of stronger and more efficient investment.
The classic objection to this course is that fiscal consolidation slows growth, hurting
revenues, which makes cut-backs self-defeating. However, there is good evidence
that the composition of consolidation matters.20 Empirically, spending cuts tend to be
more growth friendly than higher taxes. Furthermore, a fiscal consolidation that
reduces fiscal and sovereign risk would also create more room to support demand
with lower interest rates, including at the longer end of the yield curve, where South
Africa's risk premium is largest, and where
long-term investment is often financed.21
De-risking the economy, through fiscal consolidation, does not therefore need to be
contractionary.22
18
Both gross savings and investment have fluctuated in a range of 13-16% of GDP in recent years. IMF WEO
data for the period 2019-2022 (which includes a forecast for 2022) show average savings at 15.1% of GDP and
average investment at 14.1% of GDP. It is unusual for SA savings to be higher than investment; the 2010-2019
averages are 17.3% of GDP for investment and 14.5% of GDP for savings.
19
On the desirability of investment rates at 30% of GDP, see Enoch Godongwana. "Keynote address by
Minister of Finance, Enoch Godongwana, at the GEPF annual leadership conference". 15 September 2022.
Available at:
http://www.treasury.gov.za/comm_media/speeches/2022/2022091501%20SPEECH%20BY%20MINISTER%20E
NOCH%20GODONGWANA%20AT%20THE%20ANNUAL%20GEPF%20CONFERENCE%202022.pdf
20
Alberto Alesina, Carlo Favero and Francesco Giavazzi. Austerity. Princeton University Press: Princeton, New
Jersey. 2019.
21
Christopher Loewald, David Faulkner and Konstantin Makrelov. "Time consistency and economic growth: a
case study of South African macroeconomic policy" SARB Working Paper. No. 20/12. 25 November 2020.
Available at:
https://www.resbank.co.za/content/dam/sarb/publications/workingpapers/2020/10421/WP%202012.pdf
22
Roy Havemann and Hylton Hollander. "Fiscal policy in times of fiscal stress" WIDER Working Paper. No.
52/2022. Available at: https://www.wider.unu.edu/publication/fiscal-policy-times-fiscal-stress
Fiscal consolidation would also have important implications for our longer-run ability
to protect the value of the rand, which is a central concern for us as the SARB. One
of the papers discussed at Jackson Hole this year was about the relationship
between fiscal and monetary policy, and it offered the following warning:
When fiscal imbalances are large and fiscal credibility wanes, it may
become increasingly harder for the monetary authority to stabilise
inflation around its desired target. If the monetary authority increases
rates in response to high inflation, the economy enters a recession,
which increases the debt-to-GDP ratio. If the monetary tightening is
not supported by the expectation of appropriate fiscal adjustments, the
deterioration of fiscal imbalances leads to even higher inflationary
pressure. As a result, a vicious circle of rising nominal interest rates,
rising inflation, economic stagnation, and increasing debt would
arise.23
A central bank can do a great deal for price stability. It can nurture a reputation for
controlling inflation. It can also accumulate foreign exchange reserves, to help
protect the solvency of the country.24
But central banks are not immune to fiscal outcomes. If we are to maintain moderate
levels of inflation in South Africa, we will need a macro strategy that delivers fiscal
sustainability. There have been some signs of progress lately, but we are still
running fiscal deficits near 6% of GDP, despite record commodity prices. We have
seen before, and we know high commodity prices do not last forever. At some stage,
the commodity prices will correct, and we had better be prepared for it.
For monetary policy, our immediate priority is to guide inflation back towards the
middle of our target range. Our larger strategic goal, however, is to undo the error of
20 years ago, when we gave up on lowering the inflation target.25 A recent review of
monetary policy conducted by Athanasios Orphanides and Patrick Honohan makes a
compelling case for a lower inflation target of 3%.26 This target would be in line with
our peers. It would allow for lower interest rates. It would also make inflation less of a
concern in the everyday lives of South Africans.
Low inflation is like reliable electricity: good policy means most people don't have to
worry about it. Unfortunately, just as we have load-shedding, so our high and wide
inflation target means the currency suffers persistent value-shedding. We would like
this to end.
To conclude, globally the big macro news is a newfound focus on economic
constraints. There are still a few people who embrace a naïve economic policy
model, where growth is guaranteed so long as monetary and fiscal policy are
aggressive enough. But this recipe creates serious vulnerabilities to shocks in even
the strongest economies, such as the United States, and it is untenable in emerging
markets like South Africa.
For South Africans who are serious about development, the main effort should be
doing the hard microeconomic work of raising productivity, which means nurturing
expertise to solve problems, one by one, with the private and public sectors each
contributing what they can.
But this essentially microeconomic mission needs to be set in a macroeconomic
framework that is resilient enough to sustain growth, without succumbing to balance-
of-payments constraints, debt distress or high inflation. It is hardly a magic formula.
There are no shortcuts to development. The real trick is to look the problems
squarely in the face, figure out a strategy for dealing with them, and implement it. We
have no shortage of plans. After nearly a decade of going backwards, I hope we can
find the resolve to reform once again.
Thank you.