“I used to think that if there was reincarnation, I wanted to come back as the president of the US or the pope. But now I would like to come back as the bond market. You can intimidate everybody.”
These are the words of James Carville, a long-time Democratic political operative and senior adviser to then US president Bill Clinton. He was responding to a question from a journalist about the mood inside the administration after a dramatic increase in US 10-year yields from 5.2% to more than 8% in just under a year. The spike in borrowing costs was widely seen as a vote of no confidence in the US government’s fiscal policy stance.
When SA adopted the inflation targeting policy in 1999 it chose a 3%-6% target range with the idea that it would reduce the range from 3%-5% over time. However, the currency crash of the 2001 put paid to those plans.
I am certain that inside the Reserve Bank there are teams of highly qualified statisticians who burn a lot of energy understanding inflation trends and trying to figure out where inflation might be headed. Equally, governor Lesetja Kganyago spends a lot of time communicating with market participants the Bank’s goal of anchoring inflation at around the midpoint of the 3%-6% target range.
The inflation targeting policy and its attendant impact on monetary policy is one of the Left’s favourite “bogey men”. But I find the criticism often lacking in substance. We know from economic textbooks and also the experience of other emerging markets that low inflation is an ally of development.
There are several reasons why this is the case. First, low inflation helps maintain the value of the money in your pocket. This is good for all South Africans, but especially the marginalised and poor, those without the information or power to protect themselves from inflation.
Second, low inflation also helps maintain the competitiveness of local goods and services in foreign and domestic markets, by moderating real exchange rate depreciation.
Third, low inflation produces structurally lower interest rates. Perhaps it is worth pausing here and explaining this point further.
In 1930 American economist Irving Fisher found that the interest rate charged for a loan will include expected inflation plus a real rate of interest. The inflation part of the interest rate ensures that a lender gets their initial capital back when the loan is repaid. On top of that is a small payment to compensate the lender because the capital cannot be used for any other purpose while it is with the borrower — the so-called term premium. In addition, the lender also gets paid some insurance against the borrower defaulting — the “risk premium”.
These two premiums are generally small and the largest part of the nominal interest is the inflation rate. So the easiest and most sustainable way to structurally lower interest rates is to drive inflation down and keep it stable.
This is especially important for a country such as SA, which finds itself at an important fiscal crossroad. Adding to an already weak fiscal position, the events of the past two weeks have forced social welfare transfers such as the basic income grant (BIG) firmly back onto the table.
Given the seemingly broad political support for such a grant to alleviate devastating poverty and unemployment levels, the question rightly shifts to how SA will finance it.
While no sane policymaker would advocate borrowing to fund consumption, there is a compelling case to ensure that we systematically drive down SA’s yield curve. And one way to achieve that is to drive down inflation even further and reduce and narrow the inflation target range.
Already, SA’s inflation target range is higher (and wider) than that of peer countries like Brazil, Chile, China, Colombia, India, Indonesia, Mexico and Russia.
While SA’s news and political cycle always moves at a frenetic pace, it is important for policymakers to look beyond the milieu of wanton destruction of last week’s attempted insurrection and use the opportunity presented by record low inflation levels to structurally shift inflation lower.
The Reserve Bank’s monetary policy committee should place the debate over lower inflation firmly on the national agenda, After all, there is no long-term trade-off between growth or inflation. Keeping inflation low and protecting the value of the currency is supportive of growth.
Khoza is an investment banker based in Johannesburg and a Polisee Space associate.
Disclaimer: This article was originally published by Business Day.