Our constitution provides the mandate for the Reserve Bank: “To protect the value of the currency in the interest of balanced and sustainable growth.”
The constitution sets out the mandate in this way for a simple reason. It is an expression of a public good. Attaining that public good helps us reach the kind of economic growth we want.
It does not mean that achieving our mandate alone will necessarily generate that outcome. But it is necessary to achieve it. Many other policies and behaviours play similar necessary, but not sufficient, roles.
Having been given a mandate, the central bank needs to achieve it. That requires setting out an operationally relevant policy target and ensuring the institution has the powers to hit it. Central bank independence is really about giving the Reserve Bank the institutional freedom to get on with those two things.
Independence also creates space for the Bank to consider how best to achieve the mandate, in consultation with the government, and with full transparency to the general public. As an institution we worked with the government to identify the inflation-targeting framework as the best way of achieving the mandate.
Ensuring that independence delivers good, socially optimal, outcomes also requires that it is conditioned by a complementary framework that ensures transparency and accountability.
We believe the case for the existing framework remains very strong. We have achieved an historically low rate of inflation and, as a direct consequence of that, historically low interest rates. Of course we would like to improve on this track record and edge inflation and interest rates lower on a sustainable basis.
But of course, hitting an inflation target is not a simple a matter of declaring the target and browbeating economic actors to set prices and wage demands in line with it. For those actors, the gains of higher (or lower) inflation exceed the costs they experience, while society as a whole bears the full cost. This is a common political economy problem — it arises in many areas of policy. And because of it, nearly all countries choose monetary policy frameworks with clear and simple targets, and with targets that imply balanced growth.
However, ensuring that independence delivers good, socially optimal, outcomes also requires that it is conditioned by a complementary framework that ensures transparency and accountability.
Paul Tucker, a former deputy governor of the Bank of England, set it out in this way: central bank delegation should have the following principles, he said: “A clearly articulated regime, simple instruments, principles for the exercise of discretion, transparency that is not deceptive, engagement with multiple audiences, and, most crucially, testimony to legislative committees.”
In line with those principles, and to get to low inflation, central banks need to explain what they are doing and how they are doing it. And they need to be held accountable. Independence is the flip side of accountability — a central bank cannot be easily held to account if private or political actors have the ability to sway that bank’s decisions.
We have been consistent about our aim for inflation to come out near the middle of our target range, around 4.5%. This gives scope for variation and shocks to the economy. These shocks move inflation above and below 4.5% but, by design of our framework, do not necessarily require policy adjustments. This is the meaning of “flexible” inflation targeting, and it allows us considerable leeway in looking through or past temporary shocks to the inflation rate. Since the beginning of the inflation targeting period, which started in 2000, our average annual inflation rate has been 5.5%, a full percentage point higher than the midpoint.
This points to mixed success in our inflation management. Inflation has stayed moderate, well below the high levels of the 1980s and 1990s. But inflation has not really been sufficiently low to get our high long-term interest rates lower, and this creates an economic cost that weighs more heavily on job creation as time goes on. We have indicated that a consistently lower rate in the near term, at the mid-point of our target band at 4.5%, would lower long-term interest rates and be more supportive of balance in the economy.
There is ongoing discussion about whether inflation targeting is a good expression of our constitutional mandate to support balanced and sustainable growth. Independence helps central banks to keep on top of global research and use human capital to best understand how to achieve their mandates. Often criticism of independence is really about not liking the objective set out in the constitution. If the Reserve Bank had no independence, then better objectives could be imposed on it. But what are those “better” objectives, and where do they come from? Have they been researched and understood properly? Or are they wishful thinking?
Perhaps they reflect good intentions and legitimate aspirations. But the test of whether they are the right or even useful objectives has to be based on analysis and research, comparative assessment and technical know-how. Inflation targeting has in recent times become a popular policy framework mainly because it has proven successful in achieving good outcomes where others have failed. It has achieved lower inflation, while minimising short-run costs that can arise in the pursuit of it.
We often hear that our mandate should include job creation as a target. But like other inflation targeting central banks, our framework already includes concerns about growth and employment. And because we apply the framework flexibly, we do not respond with policy to every upward move in inflation. The difference between a flexible inflation target and a dual mandate central bank just isn’t very meaningful. Over time, keeping inflation expectations low and well-anchored is the clearest and most effective way a central bank can help the economy achieve full employment.
Like the constitutional mandate, central bank independence is not a static, ivory-tower concept. It is a living and breathing idea. It is an idea that is practical. It gives life to our efforts to achieve balanced and sustainable economic growth for all South Africans.
• Kganyago is Reserve Bank governor. This is an edited version of a lecture he delivered at Stellenbosch University.
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