T T Mboweni: The objectives of monetary policy with reference to the
independence of the South African Reserve Bank
Address by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Free State Branch
of the Economic Society of South Africa and Chamber of Trade and Commerce, Bloemfontein, on
12 April 2000.
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1. Introduction
The task of macroeconomic policy is the promotion of economic growth and development, the
creation of more jobs and the employment of more people, the improvement of the living conditions of
all the people of the country, and the elimination of unjustifiable discrepancies between average
incomes of various groups of participants in economic activity.
Monetary policy, being a part of macroeconomic policy, has but an intermediate role to play in the
implementation of overall macroeconomic policy. It is expected of monetary policy to create and
maintain a stable financial environment within which overall economic activity can be expanded.
None of the above ultimate objectives of macroeconomic policy will be attainable in an environment
of unstable financial conditions. Although overall financial stability by itself cannot guarantee the
achievement of the ultimate macroeconomic objectives, it is an important precondition for reaching
those goals.
In order to comply with its obligation and to meet its commitment, the central bank should pursue its
objectives with a medium and longer term view in mind. Financial stability should, for example, be
maintained throughout the business cycle in both the expansion and contraction phases of the
economy, and should in the democratic political system of periodic elections, stretch beyond the
duration of successive governments. It is inter alia for this reason that central banks need some
autonomy for the execution of their duties.
2. Primary objective of the Bank
The primary or strategic objective of the Reserve Bank is therefore to achieve and maintain stable
financial conditions in the country. This objective is spelled out in both the Constitution of the
Republic and in the South African Reserve Bank Act. In these acts it is recognised that only by
protecting the currency can balanced and sustainable economic growth be achieved.
The question may be asked what is meant by the term financial stability? In a broad sense financial
stability can be defined to include price stability as well as stable conditions in the financial sector as a
whole. Price stability is achieved when changes in the general price level do not materially affect the
economic decision-making process. Although relative price movements will still have an impact on
production, consumption and investment, the rate of inflation or deflation is not an important factor in
the decisions taken by producers, consumers and the authorities under stable price conditions.
The stability of key institutions and markets in the financial system is achieved when there is a high
degree of confidence that the financial infrastructure of the economy is able to meet the requirements
of market participants. However, it is important to realise that financial stability does not exclude the
failure of individual banks or financial institutions. A financial institution can go bankrupt in stable
financial conditions. It is only where systemic risks arise, i.e. where the financial sector as a whole
may be influenced by an incident, that the situation can be described as financially unstable.
The two elements of financial stability, i.e. price stability and stability of the financial sector, are
closely related. Failure to maintain one of these elements provides a very uncertain operating
environment for the other, with causality running in both directions. For example, high inflation can
lead to tighter monetary policy, higher interest rates, and increase in the non-performing loans of
banks and a fall in asset and collateral values, which can cause bank and other failures in the financial
sector. Conversely, disruptions in the financial system will make the transmission mechanism of
monetary policy less effective and can materially affect changes in the general price level.
3. Why is it important to maintain financial stability?
There are many convincing reasons why financial stability is regarded as a prerequisite for the
promotion and support of economic development. All modern market-oriented economies are based
on the extensive use of money as a unit of account, as a means of exchange and as a store of value.
Money that changes in value all the time cannot fulfil these functions. Money must be trusted by the
public to be a constant yardstick of value, otherwise it will not be acceptable as a means of exchange,
and cannot continue to serve as a store of value.
The many disadvantages of inflation are well-known. High inflation distorts the allocation of resources
and favours investment in non-productive hedge assets. High inflation discourages saving and leads to
more consumption. High inflation erodes the competitiveness of local manufacturers and other
producers vis-à-vis foreign producers. High inflation leads to an unfair redistribution in wealth by
penalising the poor more than the rich. High inflation leads to lower growth, fewer jobs and more
unemployment.
There can be no rational reason for the support of inflation in any country except by those few
financial wizards that have learned how to take advantage of inflation at the cost of their fellow human
beings. This may even include the managers of the national budget who have learned through
experience that taxation through inflation often meets with less resistance from ill-informed tax
payers. For the economy as a whole, however, inflation is always bad.
An argument is often made for a trade-off between inflation and growth based on the Philips-curve
analysis in terms of which, at a low level of inflation, real growth can be stimulated through an
expansionary monetary policy, even if it should create some higher rate of inflation. There may be
some truth in this for the short-term but it is easy to prove that a continuing expansionary monetary
policy will eventually lead to an acceleration in the rate of inflation. A little bit of inflation once
started can easily gain momentum, get out of control and develop into hyper-inflation. It is also true
that with modern electronic forecasting techniques and increasing sophistication in the role of rational
expectations, the effective period for the trade-off has become very short.
4. How does the Reserve Bank achieve financial stability?
Inflation is a monetary phenomenon, i.e. inflation cannot take place without a more rapid increase in
the quantity of money than in output, provided that the velocity of circulation of money remains
unchanged. Although the causes of inflation are too wide for any individual institution to prevent it
from occurring, the Reserve Bank can at all times use the powers at its disposal to reduce inflationary
pressures by influencing the growth in money supply and bank credit extension.
The Reserve Bank can influence money supply and bank credit extension either by influencing overall
liquidity in the banking sector, that is, by influencing the supply of money or by influencing the
demand for credit emanating from the private sector. Liquidity in the banking sector can be influenced
through various operational instruments, such as changes in minimum cash reserves for banking
institutions, open market-operations and short-term money market interventions through swaps and
repurchase transactions.
The demand for bank credit is to an important extent interest rate driven. By influencing the general
level of interest rates, the Reserve Bank can exert some influence on the total demand for credit, and
therefore on the money supply. The main operational instrument in this case will normally be the repo
rate, that is the interest rate at which the Reserve Bank provides in the liquidity needs of banking
institutions.
In its objective to establish and maintain financial stability another important responsibility of the
Reserve Bank is to encourage and support the development of sound and well-managed banking
institutions. The objective of banking supervision is to ensure that banks manage their risks in such a
way that systemic risk in the banking sector is minimised, thereby ensuring the safety of depositor's
money. Banking supervision is based to a large extent on the prudential regulation of banks, which is
aimed mainly, but not exclusively, at promoting the financial soundness of banks and of the banking
system as a whole.
In order to fulfil the responsibility for systemic protection of the banking system, bank supervision
must ensure the prudential soundness of participants in the banking system. As soon as a bank failure
could cause a systemic problem, the prudential and systemic measures pertaining to the supervision of
banks converge. If a large bank is in financial difficulty, the expectation of losses may become so
widespread that the public loses confidence in the banking system as a whole, causing withdrawals of
deposits and general liquidity problems in the banking system.
Financial stability also requires well-developed and efficient functioning financial markets. The basic
foundation for the functioning of markets is the provision of money. It is therefore an important
function of the Reserve Bank to issue banknotes and coin in South Africa.
In any payment system there arises the need for clearance and settlement of claims of banks on one
another because cheques drawn on any particular bank will in many cases be deposited by their
holders with other banks. This function of clearance and settlement has therefore been performed by
the Reserve Bank since 1921.
In its endeavours to maintain financial stability the Reserve Bank also has a vested interest in the
development and functioning of the money, capital and foreign exchange markets. Although the Bank
is not directly responsible for the development of the money and capital markets, considerable effort
has been made in the past to establish efficient markets in South Africa. For the efficient functioning
of the money market, daily cash shortages in the banking system are accommodated by the Bank
through the extension of overnight loans against suitable collateral to banks. As custodian of the
country's gold and other foreign reserves the Bank is also involved in the functioning of the foreign
exchange market. In recent years, the Bank in close cooperation with the Minister of Finance has made
considerable effort to gradually phase out exchange controls and to integrate South African financial
markets further with international markets.
5. The autonomy of the central bank
In fulfilling its primary objective of creating and maintaining financial stability, it is generally argued
that the central bank should be able to do this relatively independently of any government interference
or in an autonomous way. The traditional argument in favour of a strong autonomous central bank is
that the power to spend money should in some way be separated from the power to create money.
According to this argument politicians generally have short-term horizons in determining economic
objectives. Many governments have accordingly given way to the temptation to reduce interest rates
ahead of elections. This may boost spending and employment in the short term, but ultimately it
normally also causes higher inflation over the long term unless the capacity of the economy can meet
this higher level of demand. This higher inflation, however, only becomes apparent a couple of years
later. An incumbent government concerned about its immediate popularity is likely to be tempted to
go for the short-term gains from lower interest rates, even at the risk of promoting somewhat higher
inflation further down the road because some other political party may then have to pick up the pieces.
Central bankers normally operate on a longer term time scale than politicians and therefore do not face
the same temptation to relax policy to achieve short-term objectives. By delegating decisions on
interest rates and other monetary matters to such an independent institution, with a clearly defined
mandate, society can then hope to achieve a better inflation outcome over the longer term.
The main criticism against making central banks autonomous entities is not so much based on
economic but rather on political arguments: it is that turning over decisions regarding interest rates,
exchange rates, the efficiency of the financial system and other monetary matters to a body of
unelected officials is simply "undemocratic". In a democratic government all decisions should be
subject to scrutiny by the elected legislative and the concept of an autonomous central bank is
therefore not acceptable.
Aside from the fact that there are plenty of other areas of national life in which decision making is
delegated to independent unelected officials - the judiciary being the prime example - there is a
fundamental confusion here between being autonomous and lacking accountability. No central bank
can be totally independent, in the sense that it is not answerable to any one. Even the most autonomous
central bank has to report in one form or the other to the legislative, which in any case also has the
ultimate power to change the laws relating to the central bank. All the same, there is a difference
between a situation in which the policy decisions are under continuous scrutiny, and an arrangement
where the central bank reports to the legislative periodically.
An important precondition for central bank autonomy is therefore credibility. Central bankers that seek
autonomy must commit themselves and their institutions to a programme of action that will support
their demands. It is generally believed in this regard that they should fulfil three basic conditions,
namely:
(i) Central banks should have a clearly defined monetary policy framework and monetary
policy operational procedures. Monetary policy should clearly indicate what it is attempting
to achieve, how it will achieve it and in what manner it will operate to reach its primary
objective.
(ii) Both the government and the public should on a continuous basis be informed regarding the
monetary policy stance pursued by the central bank.
(iii) An efficient institutional framework should exist within which decisions on monetary policy
can be made without undue interference by political functionaries. This involves decisions
regarding the ownership of a central bank, the management of the bank and the responsibility
for monetary policy.
The final question then arises: does the South African Reserve Bank fulfil these conditions and what
degree of independence does the Reserve Bank have?
The Reserve Bank in the past has always clearly indicated what monetary policy framework and
monetary operational procedures it follows in the application of monetary policy. Only last week on
6 April we again issued a statement explaining the new monetary policy framework of inflation
targeting to the public. In this statement we confirmed that inflation targeting would have no material
affect on our operational procedures which we have been applying since March 1998.
The South African Reserve Bank also fulfils the second condition for autonomy, namely transparency.
The numerical inflation target was announced explicitly to the public to indicate clearly what the
Reserve Bank should be held accountable for and to make the application of this framework as
transparent as possible. The announcement of the target makes the intentions of monetary policy
explicit. If targets are not met, the central bank has to explain what went wrong. Regular reporting on
the stance of monetary policy, as is the case internationally, are made to Parliament.
The monetary policy stance is communicated regularly to the public. This is done by means of a
monetary policy statement after the completion of every meeting of the Monetary Policy Committee.
A Monetary Policy Forum has also been established to open an avenue for ongoing discussions on
monetary policy and general economic developments and to ensure that the views of interested parties
are taken into account in the determination of monetary policy. The Monetary Policy Forum will meet
twice a year in the major centres of South Africa to allow as many stakeholders as possible to
participate in these discussions.
The Reserve Bank will also publish twice a year a Monetary Policy Review to increase transparency in
the application of monetary policy. This Monetary Policy Review will attempt to describe in more
detail the decisions taken by the central bank and will analyse developments in South Africa and the
rest of the world that could affect inflation.
Finally, the present institutional framework in South Africa in the form of the South African Reserve
Bank Act, Act No. 90 of 1989, provides the Reserve Bank with a great degree of autonomy in its
operations. The Reserve Bank's functional independence on monetary and related policies is clearly
stated in Sections 10 and 35 of the South African Reserve Bank Act. Section 35 empowers the Board
of the Bank to make rules "for the good government of the Bank and the conduct of its business". In
Section 10 the powers and duties of the central bank are spelled out in great detail. Most of the
functions described in this section are the normal functions that one would expect a central bank to
perform. In Section 10(2) it is also clearly stated that "the rates at which the Bank will discount or
rediscount the various classes of bills, promissory notes and other securities, shall be determined and
announced by the Bank from time to time", clearly giving the Bank the right to determine Bank rate in
an autonomous manner.
The personal dependence of the Reserve Bank is determined by Section 4 of the Act indicating the
conditions of appointment of the Governor, three deputy governors and other board members of the
Reserve Bank. This section clearly precludes any person actively involved in politics of becoming a
board member of the Bank. Seven of the directors, including the Governor and three deputy governors,
are appointed by the State President, while the other seven are elected by the shareholders. By means
of these appointments the government, of course, have an effective say in the policies of the Bank. The
governors are, however, after their appointment normally allowed to operate in an independent
manner.
The instrumental independence of the Reserve Bank is clearly spelled out in the Act and the Reserve
Bank is precluded in Section 13(f) of making excessive direct purchases of government stock. In this
last-mentioned section it is stated that the Bank may not "hold in stocks of the Government of the
Republic which have been acquired directly from the Treasury by subscription to new issues, the
conversion of existing issues or otherwise, a sum exceeding its paid-up capital and reserve fund plus
one-third of its liabilities to the public in the Republic". This section therefore restricts the direct
financing of government deficits.
The South African Reserve Bank is also financially independent from the government because of
adequate financial resources and complete control over its own budget.
6. Conclusion
The South African Reserve Bank is therefore at present, according to all distinguished principles, a
fairly autonomous central bank and fulfils all the main conditions necessary for independence. The
Constitution of the Republic of South Africa also formally recognises the independence of the Reserve
Bank. The Constitution namely states in Section 196 that: "The South African Reserve Bank shall, in
the pursuit of its primary objective .... exercise its powers and perform its functions independently,
subject only to an Act of Parliament .... provided that there shall be regular consultation between the
South African Reserve Bank and the Minister responsible for national financial matters".