mr. stals discusses monetary policy challenges in south africa address by the governor of the south african reserve bank, dr. chris stals, at a south african financial markets conference arranged by standard bank of south africa limited in cape town, on 7 / 11 / 97. 1. challenge number one - to find consensus on what the objective of monetary policy should be in south africa in the international community of central bankers, there is widespread consensus that the primary goal of monetary policy must be domestic price stability. price stability, however, is only a means to an end, and not a final goal of overall macroeconomic policy. the ultimate goal is determined by governments and is normally linked to the objective of maximum economic growth, development and the creation of more employment opportunities. contemporary economic theory supports the view, however, that financial stability, as measured by a low rate of inflation, is a precondition for the attainment of optimum economic development. furthermore, monetary policy, being only one of the sub - elements of overall macroeconomic policy, is tasked with the responsibility to create and maintain such a stable financial environment that will be conducive for sustainable economic growth at an optimum rate in the medium and longer term. in south africa, however, confusion remains on what the task and the functions of the central bank should be. the most important delusion, supported by certain business people, politicians and even some academics, is linked to the now defunct phillips curve approach in terms of which the assumption is made that a higher inflation rate can produce a sustained lift in growth and employment. world - wide experience, as long back as in the 1970s, provided sufficient evidence that the assumed trade - off of higher inflation for lower unemployment could only be exploited over the limited period in which inflation expectations did not fully adjust to the new higher rate of inflation. with a more effective implementation of the theory of rational expectations within modern communities, this limited period has indeed become very short. another reason why the conventional theory of demand management through the application of monetary policy is no longer appropriate is the major shift that took place in recent years in macroeconomic management, away from conventional keynesian demand management to contemporary supply - side economics. the phillips curve approach is based on the theory of demand - driven inflationary or deflationary conditions. the world - wide situation in the 1970s, when there was a simultaneous rise in inflation and in unemployment in many of the industrial countries, refuted the theory of the trade - off and forced

e. the net gold and other foreign reserves of the bank less the balance on its net oversold forward book. for example, on 30 september 1998 the nofp reached a peak of us $ 23, 2 billion. despite this active intervention, large fluctuations occurred in the weighted average external value of the rand, particularly during the second half of the 1990s in an environment of more liberalised exchange controls. the monetary policy measures, however, achieved considerable success in bringing the rate of inflation down. after inflation in the consumer price index had generally fluctuated around a level of about 15 per cent in the late 1980s and the beginning of the 1990s it moved below double digits in 1993 and declined to 5, 2 per cent in 1999. in february 2000 the government announced that south africa had formally adopted an inflationtargeting monetary policy framework to make monetary policy more transparent and accountable and to promote a more co - ordinated approach with other policy measures. in the application of inflation targeting in south africa, it was decided to leave the external value of the rand to the market and not to intervene in the foreign - exchange market to influence the exchange rate. it was realised that this could lead to volatility in the exchange rate of the rand. although the bank would have preferred to operate in an environment characterised by exchange rate stability, cognisance is taken of the fact that fluctuations in the external value of the rand are unavoidable in the current international monetary system of generally floating exchange rates. in these circumstances the authorities can only aim at creating underlying economic conditions that are conducive to exchange rate stability. fluctuations in the exchange rate of the rand have nevertheless complicated the implementation of monetary policy. for example in 2002 monetary policy was dominated by inflationary pressures arising from a substantial depreciation in the external value of the rand in late 2001, combined with a sharp rise in international oil prices as well as in domestic food prices. these external shocks were responsible for a surge in the twelve - month rate of increase in the cpix from a low of 5, 8 per cent in september 2001 to a peak of 11, 3 per cent in october 2002. restrictive monetary policy measures and the subsequent recovery in the exchange rate of the rand then brought the rate of increase over twelve months in the cpix down to 4, 4 per cent in march 2004. with the adoption of the inflation targeting framework, it also became the stated objective of the reserve bank to reduce the nofp because of the negative