lesetja kganyago : issues confronting monetary policymakers in south africa address by mr lesetja kganyago, governor of the south african reserve bank, at the thomson reuters economist of the year awards jse limited, sandton, 11 august 2015. * * * good morning, ladies and gentlemen, and thank you for the opportunity to deliver the keynote address at this prestigious awards ceremony. this competition is about forecasting a number of economic variables. predicting the future is difficult at the best of times, and with the economic environment becoming increasingly turbulent, forecasting is becoming that much more difficult. it is also a challenging time for policymakers ; in the face of heightened uncertainty, our decisions become more datadependent than usual. this makes it more difficult for analysts to forecast policy moves. we interact with market participants and other interested parties on a regular basis to help them understand our thinking on various issues. in the recent past, a number of questions have repeatedly come up, and in my address to you today, i will focus on three of these interrelated questions. first, how should monetary policy respond to changes in the exchange rate, particularly when driven by terms - of - trade shocks? second, given the importance of us policy normalisation in our communication, does this mean that the bank follows global interest rates in making policy decisions? and finally, how does the bank think about inflation expectations? responding to exchange - rate shocks since the beginning of 2014, when the bank started the tightening cycle, the rand has depreciated by about 18 per cent against the us dollar and by about 6 per cent on a tradeweighted basis. for some time, we have been indicating that the rand exchange rate is one of the main upside risks to the inflation outlook. however, this does not mean that we target the rand in any way : the rand is but one of a number of determinants of inflation acting simultaneously, sometimes in different directions and with varying intensities. monetary policy actions do not attempt to influence the exchange rate but rather focus on the overall inflation outlook. a complicating issue recently has been the fact that the traditional pass - through relationship from the exchange rate appears to be lower than during previous episodes of rand weakness. time will tell whether or not this is a cyclical phenomenon which may be reversed at some stage, or whether it is of a more structural nature. a number of factors have impacted on the rand, and i will highlight three

currencies of other commodity producers have also been affected, in some cases more so than the rand. since the beginning of the year, for example, during which time the rand has depreciated by about 9 per cent against the dollar, the rand remains more or less unchanged against the australian dollar and the russian ruble, but has appreciated by about 8 per cent against the new zealand dollar, by about 17 per cent against the brazilian real, by about 2 per cent against the chilean peso, and by about 3 per cent against the canadian dollar ( although there was generally a good deal of volatility between these two periods ). monetary policy reactions have differed ; over this period, monetary policy has been tightened in brazil, unchanged in chile, and loosened in australia, canada, and new zealand. the question is how monetary policy should react to different categories of shocks. textbooks distinguish between portfolio shocks and terms - of - trade shocks ( apart from standard domesticdemand shocks ). the challenges posed to the rand by the us policy uncertainty clearly fall into the category of portfolio shocks. here, literature tells us that policymakers should respond to these shocks by tightening monetary policy. in an inflation - targeting framework, the tightening would depend on the extent to which the weaker exchange rate was expected to impact on inflation rather than acting to protect the exchange rate per se. the role of inflation expectations ( and monetary policy credibility ) would be central to this. reaction to a terms - of - trade shock is less straightforward, as it would also depend on whether it was a decline in an export price ( for example the gold or platinum price ), which would in itself have less impact on domestic prices, or whether it was an increase in import prices ( for example oil prices ), which do impact more on domestic inflation. in general, a terms - of - trade deterioration driven by a decline in export prices implies a decline in domestic incomes which can be disinflationary. a fall in export prices may be accompanied by currency depreciation which moderates the impact of the decline in export prices on demand and inflation. a policy response would need to try and ‘ see through ’ the first - round effects of the change in the exchange rate. however, again, much depends on the extent to which inflation expectations are well anchored. where countries have inflation under control, a response to depreciation and negative termsof - trade shocks can be more supportive to economic activity. other commodity producers –