A lecture by Lesetja Kganyago,
Governor of the South African Reserve Bank,
at the Unisa Graduate School of Business
30 August 2017
Balanced and sustainable growth: the role and mandate of the SARB
Good evening, ladies and gentlemen.
The mandate and role of central banks is a hotly debated topic in many
countries around the world. In South Africa, we tend to engage in this
debate through rhetoric rather than facts. In our article published on 2
July, we set the basis for a more informed discussion.1 I would like to
open the next chapter in that dialogue tonight.
Let me start by asking: why does our money have value? Why can you
exchange it for goods and services? The money is not backed by silver
or gold or platinum. It is not backed by land. It is not pegged to another
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currency, such as the dollar or the pound. It works because of trust
trust in a promise made in the Constitution, which gives the South
African Reserve Bank (SARB) a very specific job: "to protect the value
of the currency in the interests of balanced and sustainable economic
growth in the Republic."
Today, I will explain how we go about doing that job. While there are
SARB‟s
questions of constitutional principle in recent debates about the
mandate, I would prefer to give you the economic argument for what we
do. Independence needs to be earned; it is not enough for it to be
enshrined in the Constitution. The economic argument is crucial for
-
assessing our effectiveness and for understanding why the SARB
should be independent.
There is no distinction, and hence no choice to be made, between
protecting the value of the currency and attending to the socio-economic
well-being of South Africans. Destroying the value of the rand through
inflation, reducing what it purchases in terms of daily sustenance, would
be of no benefit to anyone. The recent report by Statistics South Africa
shows that our tragic rise in poverty coincides with a time of rising
inflation and weakening growth, between 2011 and 2015.2
While we are happy to discuss alternatives to policy targets and to the
way in which we now make monetary policy, the case for the existing
framework is very strong; our own experiences and those of other
countries overwhelmingly support it. Our monetary policy framework has
helped us to achieve a historically low rate of inflation and, as a direct
consequence of that, historically low interest rates. This suggests that, in
our current economic predicament, rethinking monetary policy may not
be the best use of our time. South Africa has far more urgent economic
challenges, in particular reducing our structural unemployment rate.
How we protect the value of the currency
Let me start with a classic problem of central banking. In general,
everyone wants money to keep its value. However, everyone also wants
-
lower interest rates and there are always some people who ignore
inflation and demand lower rates straight away. Unfortunately, if you give
in to these short-term demands, you end up with more inflation and
higher interest rates. When people see that the short-term demand for
low interest rates is stronger than the long-term preference for low
inflation, they change their behaviour. For instance, banks may charge
more to lend, as protection against higher inflation. Or businesses may
put up prices in advance, speeding up inflation. As a result, the short-
term desire for lower rates ultimately gives you higher inflation and
higher rates.
This is a well-understood problem. It is what economists call a „time
inconsistency‟ problem. A solution is to make a binding commitment, a
promise people can believe over time. In monetary policy, this has
meant giving central banks their independence, leaving them to target
inflation and set the marginal cost of borrowing in the money markets.
The inflation target allows for some inflation but not too much. This is
precisely why the Constitution tells us to protect the value of the
-
currency and to do so without fear or favour. We disregard short-term,
private demands for higher inflation so that we can look after the longer-
run interests of the general public.
How, then, do we go about delivering on this mandate? Since 2000 we
have used an inflation target. This means we protect the value of the
currency as measured by changes in consumer prices. We like this
measure of value because it is relevant to the lives of all South Africans.
Furthermore, we have had more success hitting our inflation targets than
we have had with other, older approaches, such as pursuing money
supply targets or trying to control the exchange rate. Importantly, like
many other countries, we have found that inflation targeting has helped
to deliver good economic outcomes.
Why inflation targeting produces good economic outcomes
For a start, as intended, inflation targeting has helped us to get lower
inflation. In the 1980s inflation averaged about 15%. It was almost 10%
in the 1990s. Since the adoption of inflation targeting in 2000 it has been
close to 6%.
South Africans‟ living standards, especially
Lower inflation protects of
people without the power or financial knowledge to shield themselves
-
from price increases most of all the poor. I will give you a very simple
example. Bread costs about R11 at the moment.3 If inflation stays at
years‟
around 6%, bread is going to cost R35 in 20 time. If inflation goes
back to pre-democracy levels, that same loaf of bread is going to cost
R180 in 20 years. These kinds of huge price increases will leave many
more people behind. This is why higher inflation is a recipe for more
poverty and more inequality.
Lower inflation has also permitted lower interest rates. The average
prime rate in the 1990s was almost 19%. It was about 13% in the 2000s
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and has averaged just under 10% since 2010. Among other benefits
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like supporting long-term, job-creating investment this decline in rates
has contributed to the inclusion of millions more South Africans in the
market for financial services.4
Furthermore, targeting inflation has allowed us to be more flexible. When
you are aiming at a relatively slow-moving variable like inflation, you do
not need to react as rapidly as you might have had to with something
like the exchange rate. As a result, interest rate changes have been
smoother. Back in 1998, for example, before we started inflation
targeting, we raised interest rates by almost 7 percentage points in just
five months. The policy rate went to nearly 22% and the prime rate
reached 25.5%. In more recent years, by contrast, we adjusted the
policy rate by just 2 percentage points over three-and-a-half years, to
7%, before lowering it to 6.75% in July. This sort of smooth adjustment is
much easier on firms, households and government than large, rapid
adjustments.
In textbooks, there is a short-term trade-off between growth and inflation.
Many people think of this as permanent and wonder why we do not
accept more inflation so we can have more growth and more jobs. This
is not how it works. In fact, the data show clearly that inflation and
growth have moved in opposite directions, with more inflation coinciding
with lower growth and higher growth accompanied by lower inflation.
inflation eats into peoples‟
This makes sense: real incomes, making
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them poorer as they can buy fewer goods with the same money. It also
generates higher and more volatile interest rates. All of this affects
growth. So keeping inflation under control should be growth-friendly,
which is just what the numbers show.
This pattern also holds in a comparison across countries. Besides South
Africa, 11 other emerging markets adopted inflation targeting in the late
1990s and early 2000s. These included Brazil, Thailand, and Colombia.
Those with lower inflation than South Africa have had better growth and
less unemployment. This suggests that there is nothing growth-friendly
about higher inflation targets. Of course, there are many things that
affect a country‟s growth rate. But if inflation targeting is such a big
„problem‟, and if there is a significant trade-off between growth and
inflation, then countries with lower, tighter targets should have suffered
more. They did not. They did better.5
Protector‟s report, some old complaints about
Since the Public the
inflation-targeting framework have reappeared in the press. One
objection is that inflation targeting is appropriate only for advanced
economies, not for emerging markets. A second is that we should be
targeting growth or employment instead. A third objection is that inflation
targeting hurts exports because high interest rates keep the rand too
strong. I would like to explain why these are not convincing arguments
for replacing inflation targeting.
First, let me tackle the criticism that inflation targeting is allegedly more
of a „rich country policy‟. In fact, inflation targeting is popular in both
advanced economies and emerging markets. Research by the
„pure‟
International Monetary Fund identifies 28 inflation-targeting
countries.6 Of these, 20 (or 71%) are emerging markets. If we use a
broader definition, more countries qualify. There are 64 countries with a
published inflation target for 2017; 49 of these (or 77%) are emerging
markets.7 Furthermore, if anyone is having trouble hitting inflation
targets, it is the advanced economies.
Most of the central banks in the major advanced economies are below
their inflation targets and have been so for some time. By contrast,
emerging markets are mostly on target or getting there. South African
inflation, to take the most immediate example, fell back within the target
range in April this year and is expected to stay there for the foreseeable
future. The reason why emerging market central banks are doing better
than their rich country peers is probably because we know more about
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lowering inflation than raising it especially when interest rates are
already at zero. My conclusion is therefore that inflation targeting is more
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of an emerging market practice than an advanced economy one one
that has been working better in emerging markets, too.
Should we be targeting something besides inflation? I know of no central
banks that are employment targeters or growth targeters. There are
good reasons for this. Contemporary economic thinking and lots of
experience indicates that monetary policies cannot do much about
structural growth and employment problems. If you do not have enough
skilled workers, the central bank cannot mint doctors and engineers. The
thinking and experience also stresses that any trade-off between growth
and inflation, or unemployment and inflation, is short-term only. What
you can do is stabilise inflation at the target and employment or growth
at its sustainable rate.
For this reason, even the central banks with multiple mandates tend to
behave a lot like inflation targeters. The US Federal Reserve (Fed), for
instance, has a triple mandate, for low inflation, low unemployment, and
low interest rates.8 In practice, the Fed aims to anchor inflation
expectations in line with its 2% target. In turn, low inflation helps to keep
interest rates low, and the two together help to maximise employment.
One can explain US interest rate decisions pretty well using a simple
rule, as the economist John Taylor famously showed. Simply put, the
Fed reacts when inflation is not on target and when unemployment is
away from its normal levels. We consult very similar models in the
SARB, and they also describe our policy decisions pretty well. This is
because we, as monetary policymakers, already care about cyclical
variations in employment and growth. This is the nature of flexible
inflation targeting; I have never sat in an MPC9 meeting where we just
looked at the inflation rate and ignored everything else. Of course, any
inflation-targeting central bank can give you low rates if inflation is well
behaved; you do not need an extra mandate to do that. We try very hard
to keep interest rates as low as they can be given the inflation forecast.
Finally, does inflation targeting get in the way of export-led growth, by
keeping the exchange rate too strong? Back in the late 2000s, the
visiting International Growth Advisory Panel suggested that a more
competitive exchange rate could be helpful for boosting exports. The
Panel also suggested running a fiscal surplus to create space for lower
interest rates, and they encouraged us to keep inflation targeting.10 More
recently, some people have claimed that the Harvard Panel report
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shows that even experts have a problem with inflation targeting
ignoring what the Panel really said.11 They also forget that by the time
report was
the Panel‟s released, this suggestion had been overtaken by
events, with the rand having weakened again.12
In fact, under inflation targeting, excessive exchange rate appreciation
has been rare and short-lived. These discrete periods occurred when
capital flowed in as a result of high commodity prices, sustained public
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borrowing, and low yields in advanced economies not because of
inflation targeting. The inflation-targeting framework, all else being equal,
has lowered inflation and interest rates, reducing the pull on hot money
in recent times. In fact, a fundamental, and achieved, objective of
inflation targeting was to obtain a more competitive exchange rate.
Exchange rate targeting, the implicit policy of the 1990s, kept the rand
uncompetitive.
It is likely that the act of introducing the inflation-targeting framework
helped to attract capital in 2000 because it signalled a move to a much
better policy framework, but South Africa was starved of capital at the
time. Any other policy framework that improved on the previous one
would have had the same effect.
Let me make a broader point about this debate. South Africa needs
capital to develop. It also needs a reasonably competitive real exchange
rate. Achieving both is not easy, but the simple solutions occasionally
proffered are seriously inadequate. First, they invariably focus on
nominal depreciation and not on real depreciation; the inflationary side-
effects of nominal depreciation are ignored. Second, the proposals never
say anything about the implications for the fiscus, for interest rates, and
for the broader economy of targeting a specific exchange rate level.13
Third, I would like to hear why this effort would be successful in South
Africa when it has not worked well in other democracies that have tried
it. Even a cursory review of the Asian success stories shows they had a
very high savings rate and used financial and wage repression and price
controls to achieve real undervaluation. How exactly would these
authoritarian approaches to policy be implemented here?
At the end of the day, we have had a major depreciation in both nominal
and real terms of the exchange rate since 2011, yet the net export
response has been very weak. If nominal depreciation is so critical, we
should have experienced an export boom. I do not doubt that a
competitive exchange rate is useful, but it is the real depreciation that
matters here and, on balance, keeping inflation low contributes to that
aim.
Have we been too focused on inflation?
I think that inflation targeting makes sense for South Africa as it is an
effective way to uphold our constitutional duty to protect the value of the
rand. That said, we need to have some important conversations about
the South African version of inflation targeting. Reading (and believing)
some of our critics, you would think the SARB is obsessed with inflation
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and little else.
From a worldwide comparative perspective, South African inflation has
become quite high. Back in 2005, we had lower inflation than 60% of all
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countries. More recently, in 2011, we were about in the middle lower
than half, higher than half. In 2016, however, we had higher inflation
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than most other countries 80% of them. This is not just because we
had a drought and food prices were high. Based on forecasts, it will be
much the same story for 2017.14
One big reason why we have higher inflation than most other countries
is because our target is unusually high and wide, plus we typically have
inflation right at the top of the target range, close to 6%. Furthermore, of
the peer emerging markets I mentioned earlier, we are the only one
where the inflation target has not been revised down at least once.
Nowadays most emerging markets have targets of around 3% or 4%.
For instance, India adopted a 4% inflation target last year, and Brazil has
just revised its target down to 4%. A frank reassessment of the 3-6%
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inflation target which is now almost 18 years old would probably
conclude that the target should be lower. My economists have worked
on the numbers, and they report that if we want an inflation rate in line
with our trading partners, we should be aiming for 3-4%15 - that is not
where we are today.
As you can see, we are certainly willing to reflect critically on monetary
policy. But let me add that we also need to prioritise. We have been
suffering from a recession provoked chiefly by a collapse in confidence,
driven by serious policy uncertainty. We have been downgraded by all
the major ratings agencies, and we are barely clinging to investment
grade status for our rand-denominated debt. The ratings agencies tell us
that the major policy pillar that supports the South African investment
case is our monetary policy framework. Why then, in this environment,
would you want to make the discussion about changing the monetary
policy framework? As a matter of science, there are no settled questions
and more research is always appropriate. As a matter of policy, this
focus seems misguided.
Central bank accountability
What about accountability? Our fundamental purpose, as with the other
South Africa‟s system of
parts of government, comes from the
Constitution. Our job is to figure out a monetary policy framework that
delivers on this mandate. In line with many other countries, we use an
inflation target. We identify the precise inflation target after consultation
with National Treasury. This is as transparent to the public as it can be.
No one can give the SARB secret instructions. Our mission is in plain
view, and the evidence for judging us is independently produced and
publicly available, in the form of the consumer price index published by
Statistics South Africa.
Of course, this is not the only way in which the SARB is held
accountable. Our other roles and powers, such as bank supervision and
financial stability, are assigned to us by laws passed by Parliament and
signed by the President. We submit our Annual Report to Parliament.
Furthermore, the Governor and the Deputy Governors are appointed by
the President following consultation with the Minister of Finance and the
SARB‟s
Board of Directors.16 This system is designed to create the
space for the SARB to make good decisions while maintaining
democratic accountability. If you believe that the SARB is so
independent that it can ignore the public interest, you need to reflect on
how our work is specified in law and how we consult on our target.
At this point in the conversation, you can usually rely on someone to ask
SARB‟s
about the private shareholders. What is a central bank with
private shareholders doing in South
Africa‟s Constitution? Does this not
mean the SARB is run in the interests of private individuals, not in the
interests of South Africans? This has become something of a zombie
argument: no matter how many times you kill it, it keeps coming back.
The fact is: private shareholders have no influence whatsoever on
monetary policy, financial stability, or banking regulation. Their rights are
highly circumscribed. A shareholder, and his or her associates, cannot
hold more than 10 000 shares out of the total of 2 million shares in issue.
According to the SARB Act, shareholders receive a fixed annual
dividend of 10c per share. This dividend policy has not been updated in
90 years, so I am afraid it has not been a great investment.
Our total dividend payout each year is R200 000. Some of the
shareholders are annoyed by this and would like to be paid much more.
SARB‟s
However, this is not the way the shares work. Instead, the after-
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tax profits which were R1.4 billion for the last financial year mostly go
own
to National Treasury, with a small portion being kept for the SARB‟s
reserves. The shareholders got 0.014%, or roughly one ten-thousandth,
of total profits made. For the record, R200 000 is somewhat less than
the salary we pay a single junior economist. In other words, come work
SARB‟s
for us in a junior role and you will make more than all the
shareholders combined.
The fact that we have private shareholders is admittedly slightly unusual.
It used to be a common practice, and today there are still a few other
central banks with a degree of private ownership, including those of the
US, Japan, Turkey, and Switzerland. I think our shareholders are helpful
with some governance issues. It is useful, for instance, to hear from the
members of our Board with experience in the agriculture, mining, and
public sectors.
However, if we had a fully nationalised central bank, I would not be
giving speeches suggesting that we privatise it. So why not just
nationalise the SARB? Simple. It would not change anything useful that
we cannot change anyway, and it would be expensive. It would not
change anything useful because shareholders already have no control
SARB‟s
over the policy responsibilities, as I have explained. Why would
it be expensive? I will tell you another story. SARB shares normally trade
for about R3. The funny thing is: if you ask about buying SARB shares,
you will find there are standing offers to sell from people whose price is
R7 900 per share. Who would charge almost R8 000 for something that
normally sells for R3? I suspect there are sellers out there who think we
will have to nationalise the SARB in the end because it will be the only
way to kill this zombie argument about private shareholders once and for
all. As a result, they will get to make a nice profit at the expense of the
South African people. My economic advice is: let us not pay large sums
of money for purely cosmetic changes.
Conclusion
In this lecture, I have discussed how the SARB protects the long-run
interests of South Africans, and I have demonstrated that South Africa
has experienced better economic outcomes under inflation targeting
than it did previously. We are always interested in monetary policy
research, but a major overhaul of the monetary policy framework does
not strike me as our most pressing issue. Maintaining a relatively low
inflation rate helps to keep long-term interest rates low, and, all else
being equal, supports long-term investment. This also works against the
real appreciation of our currency. This is as much as monetary policy
can do to support economic growth. Low inflation and low interest rates
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just like our commodity endowment, our population growth rate and
demographic dividend, our excellent higher education system, and our
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creativity and spirit are critical to long-run growth and job creation.
Thank you.
Charts:
Bread prices at different inflation rates
200
Average inflation @ 4.5% p.a.
Avg inflation 2003 to 2016 @ 6% p.a.
R180
160
Avg inflation 1993 to 2002 @ 8% p.a.
Avg inflation 1983 to 1992 @ 15% p.a.
120
80
R51
R35
40
R10
R27
0
2017 2022 2027 2032 2037
Share of countries with public inflation
targets for 2017
Advanced
Economies
23%
Emerging
Markets
77%
l k
SA's inflation rank in the world (IMF data)
100%
90%
80%
70%
75
[VALUE]
60%
50%
40%
30%
20%
[VALUE]
10%
0%
2003 2005 2007 2009 2011 2013 2015 2017
Share of countries with higher inflation
Share of countries with lower inflation
SA percentage rank
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