After four years of debate, the Reserve Bank has gone into overdrive in its push to have the inflation target lowered from 4.5% to 3%. With consumer inflation below 3% for the past three readings, the time is right to make the move, it argues, with the country set to reap significant welfare, fiscal and economic benefits.
But the National Treasury, while conceding there is a case for revising the target, appears reluctant to make the leap. This misalignment between the Bank and the Treasury is unfortunate — not least because, though the Bank can (in theory) move without the Treasury’s approval, doing so would send out mixed messages.
And in this game, clear communication and co-ordination are everything. If the public does not believe that the authorities are wholly committed, it could undermine the powerful dampening effect of a target shift on inflation expectations. That, in turn, could increase the growth sacrifice required.
The problem is that as long as expectations settle on 4.5%, and are not reset to 3%, prices and wages will tend to increase at above 3%. The Bank may then have to keep interest rates higher in the near term to choke off demand and push inflation lower, initially sacrificing some growth in an economy where growth is stagnant.
Fiscally, there could also be short-term pain. While debt service costs should fall significantly over time as new debt is incurred at lower interest rates, the debt-to-GDP ratio is likely to worsen initially due to lower inflation and lower nominal GDP growth. And if tax revenues take an immediate hit, the fiscus could end up worse off — unless the Treasury slows the pace of spending commensurately.
In short, pursuing a lower inflation target carries short-term political and fiscal risks in exchange for the substantial long-term benefits of lower inflation. These include protecting the incomes of the poor, reducing the cost of borrowing, encouraging saving and investment, better export performance (on the back of a weaker real exchange rate) and, ultimately, stronger long-term growth.
Yes, there are risks to lowering the target. But these can be mitigated by announcing the change now — to take advantage of the deceleration in global and domestic inflation and the dampening effect this is having on inflation expectations — while giving the Bank until the end of 2027 to achieve it. This gives companies, unions and consumers time to adapt to the new target.
Admittedly, explaining these nuances to a browbeaten population, convinced that the hawkish Bank is out of touch with the needs of ordinary citizens, is going to be a hard sell in an economy that is barely growing. This is why it’s crucial for the whole of government to get on board. But when has this government ever made a short-term sacrifice for the greater good, or chosen what is right over expedience?
It is telling that in the 25 years since South Africa introduced inflation targeting, most other emerging markets have lowered their targets at least once. South Africa’s failure to reduce the 3%-6% target band to 2%-4%, as originally planned, means our inflation target — now 4.5% — remains well above that of our peers and trading partners. This weighs on international competitiveness, investment and the rand.
Many notable private sector economists have weighed the pros and cons carefully and concluded that now is the time for boldness and ambition. South Africa has an opportunity to achieve permanently lower inflation — and therefore permanently lower interest rates — at minimal cost.
We should seize it.
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