SA can lower its inflation target at little cost by applying insights from its recent experiences, Reserve Bank governor Lesetja Kganyago says.
In a guest lecture to a University of Stellenbosch audience on Thursday, Kganyago said that though SA’s relatively high inflation rate was often considered structural and inevitable, rather than a policy choice, “the fact is, we could have a lower inflation target like almost all our peers and, with it, lower inflation”.
“We have an opportunity to achieve permanently lower inflation and therefore permanently lower interest rates.
“Executed effectively, a lower target could be achieved at little cost — just as we moved to 4.5% at little cost.”
Despite the potential for a more ambitious approach, misconceptions about SA’s inflation “leave us with a macroeconomic discussion that is too pessimistic and insufficiently ambitious”.
A key example is the administered price problem, which Kganyago said analysts “too often misrepresent”.
The governor said concerns that lowering the inflation target would worsen SA’s already high administered price inflation overstated the importance of administered prices in driving inflation.
“The conversation about lower inflation should not be held hostage by administered prices,” said Kganyago.
Low trade-off
“Of course, it is highly desirable to have lower administered prices. And it is easier to have lower inflation, and lower rates, where these categories are helping, and not hurting, the disinflation effort.
“But let us not pretend we must live with a relatively high inflation target just because of our administered price problem. It did not stop us from getting from 6% inflation to 4.5%.”
The assumption that lower inflation means lower growth is equally flawed, said Kganyago, with studies showing that the trade-off could be low.
“It is depressing enough that short-term pain is considered such a decisive argument against long-term gain but even worse that it is considered a winning argument when it is not even clear there is short-term pain,” he said.
“The studies of the move to 4.5% inflation certainly do not show high costs. They show a path to lower inflation that relies mainly on communication and credibility, rather than high rates.”
Ambitious
The Reserve Bank began emphasising its midpoint inflation target of 4.5% in 2017 — effectively lowering its inflation target, because it had previously treated 3%-6% as a “zone of indifference”, which in practice meant “aiming for the top of the range and ignoring the bottom half”, said Kganyago.
In the following years the more ambitious target caused SA’s annual inflation to fall gradually from 6.3% in 2016 to 4.1% in 2019. Inflation expectations improved significantly, with survey expectations at 6% at the start of 2017 and 4.8% by end-2020.
“The new strategy worked,” said Kganyago. “Over the next few years, we achieved lower inflation and we secured broad stakeholder understanding of our revised objective.
“This is a season of reform in SA. For any successful reform, you need to start with ambition and conviction, and then you need to follow that with great care and responsibility, to get the execution right.”
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