keynote address by dr rashad cassim, deputy governor of the south african reserve bank, at the aci financial markets association south africa seeing like a central bank : the sarb, supply shocks, and the logic of higher interest rates in a world of low economic growth 6 september 2022 introduction good evening, ladies and gentlemen. the south african reserve bank ( sarb ) has increased the repurchase ( repo ) rate at each monetary policy committee ( mpc ) meeting since november of last year ; our most recent move was 75 basis points, to 5. 5 %. we are raising rates in the context of higher inflation, with headline inflation currently at 7. 8 % − well above the 6 % upper bound of our target range. i hear many questions about why we are raising rates, seeing that inflation is driven primarily by supply shocks in the form of higher global food and oil prices, while demand pressures in the economy are limited. i hope to explain today how central bankers think about what tools they have at their disposal in these circumstances. in so doing, i would like to make two points. first, we are aware of the role of supply shocks in driving inflation, and we understand that monetary policy cannot cancel out something like a sudden food price shock. the task we set ourselves on the mpc is different. our objective is to look past the immediate supply shock, focus on the period after it has subsided, and ensure inflation stabilises at that point. i will discuss what factors we consider in pursuit of that goal. page 1 of 8 second, we are starting from a point of very low interest rates. during the onset of the covid - 19 pandemic, we cut the repo rate to a record low of 3. 5 %. this was the right thing to do at the time, but rates could not stay that low forever. economic conditions have changed since 2020. we therefore need to think about the appropriate level of interest rates, given how inflation and growth risks have evolved, particularly in the past few months. one issue that i hope gets clarified by the end of my talk is that one cannot just look at the change in our interest rates from one mpc meeting to another, in isolation. the level of the interest rate is also important in our thinking – and more specifically, the level relative to what economists call the ‘ neutral rate ’. supply shocks and demand shocks in monetary theory let me start with some theory about how monetary policy should respond

while we don ’ t see today ’ s elevated inflation going away next year, we also don ’ t yet see inflation running out of control. with that said, the supply shocks that are driving inflation are significant, and we are seeing increasing risks of potential secondround effects. this justifies a policy response, rather than no response. calibrating the policy response why hike in response to supply shocks, given the low growth environment? as i have explained, our assessment of inflation is quite nuanced. in matching this nuance, we do not perceive our choices as ‘ hike ’ or ‘ don ’ t hike ’. when we make repo decisions, rather than just deciding to go up or down, we think more about the level of the policy rate. more specifically, we consider the level of rates relative to a normal or neutral interest rate, defined as the rate which would neither slow down nor speed up the economy. we also think about these rates not just in nominal terms, but rather adjusted for inflation. policymaking therefore centres on choosing a setting somewhere along a broad spectrum of real rates, with options ranging from very loose to very tight, and a wide range of choices between these extremes. this is the standard modern framework for monetary policy, as distilled, for instance, by scholars like michael woodford. 2 as with the inflation analysis, using this framework is not simple and easy. we must estimate where neutral rates are, and there is no single best practice for adjusting the nominal rate for inflation. however, with a repo rate of 5. 5 % currently, and an inflation rate starting just the classic reference is michael woodford, interest and prices, princeton university press : princeton & oxford, 2003. page 7 of 8 over 7 % and declining to just under 6 % next year, we still clearly have a negative real policy rate. this rate was significantly more negative before the rate hike in july. meanwhile, our estimated real neutral rate is in the region of 2 %, so actual rates are still well below neutral. they would also be below neutral even with different, lower estimates of neutral. this means the policy stance is still supportive of growth. i ’ ve realised that most people do not use this model, so a 75 basis point hike reads as tight policy. but this is not a good description of actual policy. the fact that we have a gap between the standard practice of monetary economists and everyone else suggests we have a lot of work to do