X P Guma: The role of monetary policy
Address by Dr X P Guma, Deputy Governor of the South African Reserve Bank, to the IPM
Annual Business Conference in association with NKR, Durban, 18 May 2009.
* * *
1. Introduction
Mr Chairman, ladies and gentlemen, let me begin by thanking you for your invitation to me to
participate in this meeting today: for me it is usually better to speak when asked than to ask
to speak.
The title of my talk today is well known to those who have an interest in and may be well
versed in the precepts of that component of public policy which is known as "monetary
policy": that is, the use of monetary instruments to influence macro-economic outcomes. This
is so because it was the topic chosen for the Presidential address delivered at the Eightieth
Annual Meeting of the American Economic Association on December 29, 19671: an
Association which remains one of the foremost scholarly associations of the Economic(s)
profession; and has been the scale upon which many nuggets of theoretical insight have
been assayed.
Theoretical elegance within the confines of the spaces occupied by trained economists is
one thing: relevance to, and understanding by, a broader public whose lives are affected by
the actions of Central Banks is another. My purpose today is to speak to the latter.
2. The Friedman Statement
For my purpose today, the questions to which answers are required are, in the main, those to
which the 1967 - address was directed, namely:
i) what monetary policy cannot do.
ii) what monetary policy can do.
A paraphrasing of Friedman would indicate that the course adopted by Central Banks in
order to achieve a particular objective, cannot:
(1) peg interest rates for more than very limited periods;
(2) ... peg the rate of unemployment for more than very limited periods.
These are, as stated in the address, only two of the limitations of monetary policy which can
be drawn from the "infinite world of negation". To the list could be added many others: for
example, easy finance for SMME's, secure and guaranteed employment for all job seekers
including graduates of tertiary institutions, full capacity utilisation for airline companies,
unlimited connections for the cellular-less and infinite airtime for the connected2.
But, monetary policy can:
iii) prevent money itself from being a major source of economic disturbance.
iv) Provide a stable background for the economy, such policy being the primary
responsibility of national central banks.
Logically, therefore, if monetary policy is to provide a stable background for the economy, it
must do so by deliberately employing its powers to that end.
3. In all places: at all times?
In stating the aforegoing, in free translation, I should not be misunderstood. I do not wish to
imply that one monetary policy is always and everywhere appropriate. Such a rendition of
this narrative would do injustice not only to the principal author to whom I have referred but
also to his antecedents, contemporaries and successors most of whom had and have,
respectively, a keen sense of history. For it is the case that the political, economic, social and
international environment of central banks is in constant flux. At the same time central banks
are quite dissimilar in their constitutions. No two Banks are exactly alike.3 Nor is it the case
that the issues to be addressed are identical at all times in all places.
The central proposition remains, however: it is that monetary policy can do certain things; in
particular, provide a stable background for the economy. In so doing, this policy will enable
producers and consumers, employers and employees to proceed with full confidence that
one aspect of an otherwise unknowable future is predictable: namely, the rate of price
inflation, or its mathematical inverse, the purchasing power of money.4 In these conditions,
entrepreneurs can plan and act; savers can save without fear that their savings will be wiped
out by inflation and borrowers can borrow in orderly markets at interest rates that are not
unduly raised by inflation risk premia.
Resolution of challenges in the real sector; for example skills shortages or drought - induced
agricultural losses requires other policies: stated differently as old people here used to say
"nobody can use another person's teeth to smile". So to end the analogy, the teeth which will
bring a smile to the resolution of those issues cannot be drawn from the mouth of monetary
policy.
4. Is price stability enough?
But this surely cannot be enough. For we all are aware of the strained circumstances of the
international economy in 2009: and are no doubt cognisant of the impact of these
developments on the prospects for the domestic economy. So, as William White asked two
years ago, "Is Price Stability enough?5 And, the short response to this could be, in my view,
"yes, in normal circumstances. No, in extra-ordinary times". That, after all, is why policy
affords some discretion to the policy-maker. Slave-like adherence to an invariant policy
stance is unlikely to yield optimal outcomes when circumstances change dramatically - as
they have in recent times.
For this reason, principally, many central banks have accepted the distinction that may need
to be drawn between price stability and financial stability. That these are not synonyms is
evident from the evidence: the worst financial crisis in history has erupted to the detriment of
global, real economic activity; and did so in the United States of America despite the low
rates of inflation that had been recorded there for some time6.
On the other hand, the proposition that price stability and financial stability are not mutually
exclusive, indeed are linked is intuitively appealing. This is so because the transmission
mechanism of monetary policy in contemporary, market-oriented economic systems is based
on the assumptions that:
1. credit markets exist and operate efficiently;
2. the policy rate of the central bank is the primary determinant of interest rates in the
market for credit;
3. there exist stable, rational and predictable relationships between money and credit,
on the one hand; and a host of macro-economic variables on the other; and
4. the demand for and supply of credit are brought into equilibrium, in part, by "the"
interest rate.
When credit markets cease to operate, or operate inefficiently, one of the channels through
which conventional monetary policy operates ceases to be, or becomes increasingly less,
effective.
There then arises a need to regain financial stability because financial instability has the
potential to cause significant macro-economic costs: it interferes negatively with production,
consumption and investment and is detrimental to broader goals of sustainable and
sustained economic growth, full or rising employment and societal development.
It may be necessary, therefore, for some institution, or college of institutions, to validate the
often unstated assumptions stated above, in order to avoid or limit financial instability: to
enhance the efficiency of monetary policy.
Such an authority should be able to, at minimum,
• identify systemic threats at an early stage;
•
promote measures to reduce these threats;
•
develop and test contingency plans and crisis preparedness;
•
in extreme cases, implement safety-net measures to support systematically important
financial institutions;
•
maintain confidence in financial markets and resolve the efficient functioning of
markets,
according to the International Monetary Forum (IMF); the Bank for International Settlements
(BIS); and the G-20 - of which South Africa is a member7.
5. In South Africa
Many countries - which differ in size, structural features and development level - have
selected inflation-targeting-with-floating as their preferred framework for pursuing a more
independent and effective monetary policy. According to Frederic S. Mishkin and
Klaus Schmidt-Hebbel8, this choice has been made, typically, by instrument-independent
central banks in open economies with a history of inflation, which need to establish a credible
monetary anchor to promote price stability.
This framework, typically, coincided with the end of experimentation with alternatives:
including, in particular, intermediate exchange rate regimes, and monetary aggregates, as an
intermediate target.
Historically, the most common nominal anchor for policy involved linking the value of the
currency to gold (under the gold standard) or to a major currency. There followed a period, in
the 1970's, during which monetary aggregates became the prevalent nominal anchor for
policy. When these became an increasingly unreliable anchor, some countries attempted to
target the exchange rate - with mixed success9.
At present, in the case of the South African Reserve Bank (SARB), as is well known, the
primary goal of monetary policy is the achievement of price stability. Stated in the words of
Section 224(1) of the Constitution of the Republic of South African, 1996, "The primary object
of the South African Reserve Bank is to protect the value of the currency in the interest of
balanced and sustainable economic growth in the Republic". And South Africa has had
experience of most alternatives - including the gold standard, the gold-dollar standard,
monetary aggregates and an eclectic approach. To use the intemperate language of the
younger generation: been there, done that; got the T-shirt.
As has been stated above, it is possible to pursue price stability using alternative
approaches: and, many have been tried.
As has been observed elsewhere in this regard, "take away inflation targeting and we will still
have monetary policy, we will still have the same instruments of monetary policy, and the
Bank will still have a constitutional mandate to maintain low inflation"10, in the interest of
balanced and sustainable economic growth in the Republic.
6. Conclusion
In conclusion, permit me to emphasise the following points: - The proposition stated in the
Address, to which I have made reference, that our economic system will work best when
economic agents can proceed with full confidence that the purchasing power of money will
be protected remains central to the role that has to be assigned to monetary policy. In South
Africa, this is a constitutional imperative.
Recent developments have thrown into sharp relief the importance of financial stability: and
some broad guidelines have been suggested, in particular, by the G-20 - of which South
Africa is a member - at the Summit held in London early in April 2009. At that Summit, the
former Financial Stability Forum was transformed into the Financial Stability Board: and was
enjoined, inter alia, to "pursue the maintenance of financial stability, enhance the openness
and transparency of the financial sector, implement international financial standards ... and
agree to undergo periodic peer reviews"11.
The institutional arrangements for accomplishing this will, clearly, differ from country to
country but will certainly not be onerous for South Africa as a great deal has already been
done in this regard. Two IMF/World Bank Financial Sector Assessment Program Studies
have been concluded; the first in 2000 and the second in 2008. Supervision of banks has
been undertaken consistently and the Basle II framework was implemented on the due date.
Moreover, within the SARB, the Financial Stability Department (FSD) has existed since the
year 2000, its task being to identify possible threats to financial stability and suggest ways in
which these could be mitigated. Although its existence cannot guarantee that financial
stability will be maintained, taken together with the existing framework which exists for the
regulation and supervision of financial institutions, its work will assist the authorities to reduce
the probability of systemic instability.
Finally, financial markets are likely to remain volatile as risk aversion and optimism about
growth prospects fluctuate in response to emerging data and conflicting signals, as the most
recent Monetary Policy Review of the SARB indicates. Dealing with this will require resolute
application of monetary policy in accordance with the mandate to achieve price stability,
within an inflation-targeting framework.
Thank you for your attention.