raises the risk premium that investors require and increases the cost of capital, thus lowering fixed capital formation. lower investment means lower future growth and less future income. if producers and consumers feel confident that the average price level will remain stable, they can be more certain that price changes indicate true shifts in demand and supply. obviously a monetary policy that maintains price stability can improve the efficient functioning of markets. this promotes the full and productive employment of resources. as alan greenspan once stated, a monetary policy that prevents inflation from being a factor in the decision making of businesses and consumers, is a monetary policy that best promotes economic growth. empirical evidence shows that high inflation has a negative correlation with economic growth. in countries where inflation is high, economic growth is normally low. many economists are therefore convinced that inflation is undesirable and should be avoided at all costs. recent economic research has cast some doubt on this argument. in principle, there is likely to be a reversal somewhere in the inverse relationship between inflation and growth as there are no grounds for believing that continuously declining prices, i. e. deflation, are good for growth. stanley fischer of the international monetary fund ( imf ) found that the inverse relationship would hold, even at low rates of inflation. another study by barro confirmed this inverse relationship, but found that it was relatively weak. increasing inflation by 1 % led to only a small reduction of less than 0. 03 % in growth, according to barro. a range of other studies found no effects from inflation on growth. sarel, a researcher at the imf, came to the conclusion that : “ when inflation is low, it has no significant negative effect on economic growth : the effect may even be positive. but when inflation is high, it has a powerful negative effect on growth. the structural break is estimated to occur where the average annual rate of inflation is 8 %. ” despite this uncertainty about the negative correlation between inflation and growth at inflation rates below 8 %, there is still no evidence of a positive correlation between inflation and growth over any long period of time. in any case, if the inflation rate is close to 8 %, it still seems wise to follow a policy countering a general increase in prices, because it could easily move to levels above 8 % and accelerate further. in south africa the 1970s were a decade of high inflation compared with the 1960s. inflation had averaged 2. 6 % per year between 1960 and 1970. in 1974 inflation moved to higher than

all, can only lead to the conclusion that the central bank must always carefully monitor economic developments to maintain price and financial stability. no country can afford to move out of line with the inflation rates in the rest of the world. 4. monetary policy and business cycles if it is so obvious that excessive money creation does not contribute to sustained economic growth, why do we hear from supposedly well - informed opinion makers that monetary policy is too tight and that it is putting a lid on real economic growth? my considered view is that some of these commentators often expect more from monetary policy than it can deliver. they tend to confuse short - term accelerations in output growth with long - term sustainable economic growth. this confusion arises because monetary policy affects aggregate domestic spending, and under certain circumstances a rise in spending can push output higher. such an increase in output will show up in growth in the short run that will be higher than the potential growth rate of the economy. such a short - term growth acceleration can be attained when there is an under - utilisation of resources. if there is a great deal of slack in the economy, then increased spending can raise the level of output. however, both the level and the growth rate of production are limited by the supply and quality of productive resources. if the employable resources are of poor quality, then output cannot increase unless there is a strong increase in the productivity of the resources already being used. at full utilisation of productive capacity, and here one recognises that in our modern technology - driven economy some resources are simply not employable in the short run, higher spending will lead to higher prices but no increase in output. under some circumstances, faster monetary growth and lower interest rates can increase demand. this in turn can lead to higher sales and output with little change in prices. under slightly different conditions, increased demand leads to inflation with little or no boost in output. the impact that a change in monetary policy will have on spending and production is uncertain at best. determining whether such a change would affect production instead of inflation will depend to a large extent on the stage of the business cycle. everyone involved in economic analysis will immediately agree that it is extremely difficult to determine the business cycle stance. the reserve bank compiles business cycle indicators for this purpose, but usually it is only possible to determine where the economy is in the business cycle a long time after the event because there is a delay in the compilation of statistics. moreover, clear trends are needed in information before