the foreign exchange and in the money markets, but mainly with the intention of supporting an orderly adjustment in market prices. it - 3was never the intention to try and fix the exchange rate of the rand at any predetermined artificial level, neither did the bank try to keep interest rates unrealistically low. it was furthermore accepted that, after the relatively large depreciation in the exchange rate and taking account also of the “ openness ” of the south african economy, the rate of inflation would rise. the challenge for monetary policy was, however, to constrain the rate of increase in inflation to a first round effect only, and to prevent prices from going into an uncontrollable and perpetuating inflationary spiral. in retrospect, the policy seemed to have worked quite well. the restrictive monetary policy, and particularly the rise in interest rates, were not received with unanimous support by all sectors of the south african community. interest rates, however, remain one of the main disciplines of the market economy and countries that are not prepared to bear the effects of this discipline from time to time will be punished by the markets. this basic lesson is now being learned again by a number of countries in the east asia region where interest rates recently soared to a much higher level than ever experienced by south africa. now that the overall macroeconomic consolidation process has made good progress, there are some impatient pressures building up on the reserve bank to relax monetary policy quickly and decisively. some of these pressures are still based on the now defunct phillips curve or an assumed trade - off between inflation and growth - - an argument that was buried in most countries of the world already in the 1980s when macroeconomic policy switched the emphasis from a demand - management approach to a supply - side solution. the rapid expansion of communications and the increase in electronically driven capacity for economic analyses further contributed to the more effective implementation of pre - empting expectations, and reduced the opportunity for central bankers to stimulate economies in the short term by applying over - expansionary monetary policies. the south african reserve bank now follows the lead of many other central banks in the world to base monetary policy decisions on developments in financial or monetary aggregates, and not on changes in real economic activity. indeed, the latest fashion is for central banks, together with governments, to target inflation more directly. taking account of typical time - lags that exist between the implementation of monetary policies and their eventual effect on prices, monetary policy adjustments are

to coincide rather with changes in the monetary aggregates and not with changes in real economic activity reduces the danger of a premature re - stimulation of the demand for bank credit, and a too early injection of excessive amounts of additional money. a monetary policy linked to changes in the business cycle could easily lead to the re - emergence of the harmful stop - go policies so often pursued by central banks in the 1960s. 2. 1997 - a year of macroeconomic consolidation developments in the south african economy in the early months of 1996, and particularly the currency crisis of february last year, exposed certain weaknesses that were developing in the south african economy at that time, and that needed early correction. the signs were already there in the first half of 1996 that the calendar year of 1997 would turn out to be a year of macroeconomic consolidation. now, eighteen months later, we can look back with some satisfaction on the progress that has been made in restoring overall economic equilibrium. firstly, in the area of real economic activity, equilibrium has been restored not only in the growth rates but also in the absolute levels of total gross - 2domestic product and total gross domestic expenditure. after increases of about 6 per cent per year in 1994 and 1995, the growth in gross domestic expenditure slowed down to 3 per cent in 1996, and to almost zero so far in 1997. the rate of growth in total production also slowed down marginally, but was still maintained at a positive level of about 2 per cent in the first nine months of 1997. these developments in real economic activity over the past eighteen months were reflected in an improvement in the overall balance of payments. the seasonally adjusted and annualised rate of the current account deficit declined from r13 billion in the second quarter of 1996 to r3½ billion in the second quarter of 1997. this improvement contributed to the adoption of a more positive attitude by foreign investors and the net capital inflow increased from less than r4 billion in the full year of 1996 to more than r16 billion in the first half of 1997. in light of the surplus that emerged on the overall balance of payments, the total gross gold and foreign exchange reserves held by the banking sector increased by r14 billion from about r17 billion at the end of december 1996 to about r31 billion at the end of june 1997. thirdly, the excessive rates of increase in the money supply and in bank credit extension in 1995 and 1996 also marginally slowed down in 1997. in the third quarter of 1997, the seasonal