It is hard to imagine that the great Argentinian footballer Diego Maradona could have anything in common with monetary policy, but he is a useful metaphor for the trick the SA Reserve Bank hopes to pull off in its bid to have SA’s inflation target lowered to 3%.
Emboldened by the Bank’s success in shifting actual inflation and inflation expectations from a sticky 6% to 4.5% over the past few years, without having to hike rates or sacrifice growth unduly, governor Lesetja Kganyago thinks it’s high time for SA to lower the 3%-6% target band to a 3%-point target.
Every other emerging market that started targeting inflation about the same time as SA did has revised its target lower at least once. The average inflation rate across other middle-income countries over the past five years has been just more than 3%. SA ranks last with an average of 4.7%.
Kganyago’s goal is to lower inflation in line with SA’s peers for all the positive welfare and competitive benefits this would bring. But clearly, if all a lower inflation target begets is higher interest rates, this wouldn’t help the economy. The trick is to permanently lower inflation without hiking rates unduly or sacrificing too much growth in the process.
Over time, the reward of permanently lower inflation would be much lower nominal interest rates. Achieving this requires ambition, self-confidence, finesse, and a bit of luck — just like any great Maradona moment.
The “Maradona theory of interest rates” was a term coined by former Bank of England governor Mervyn King. He used the two goals Maradona scored against England in the World Cup in Mexico City in June 1986 to explain how central bank credibility, and forward-looking inflation expectations, can deliver lower inflation outcomes without necessitating steep hikes in policy rates.
“Maradona’s first hand-of-God goal,” explained King in a speech in 2005, “was an exercise of the old mystery-and-mystique approach to central banking. His action was unexpected, time-inconsistent and against the rules. He was lucky to get away with it. His second goal, however, was an example of the power of expectations in the modern theory of interest rates.”
Maradona ran from inside his own half, beating five players, before scoring, and all by running virtually in a straight line. Because the English defenders reacted to what they expected Maradona to do — move left or right — he was able to go straight on.
Monetary policy works in a similar way in that it relies on the self-fulfilling power of (inflation) expectations. According to Morgan Stanley, the market narrative is that lowering the inflation target to 3% would result in additional tightening of about 50 basis points. But this assumes the Maradona effect doesn’t come into play.
However, given that the Reserve Bank is highly credible, market participants would expect monetary policy to tighten. Price setters would adjust their behaviour and market rates would be likely to rise in anticipation, cooling demand and driving inflation lower. In that event, official interest rates might not need to rise on a vastly different path than would otherwise have been the case.
Now is the perfect time to bank the disinflationary gains achieved over the past few years. The inflation outlook is benign and inflation expectations are well anchored. Inflation, excluding administered prices such as water and electricity tariffs, has averaged 3.5% so far this year.
The biggest obstacle is the government, including Eskom, the water boards and delinquent municipalities that jack up their tariffs, rates, and service charges each year, partly to cover their own inefficiencies as well as unsustainable salary increases.
Kganyago’s challenge is to get the government’s buy-in on the desirability of a lower inflation target, and to then start pricing items like water and electricity accordingly. But, given SA’s deep-seated inefficiencies, it’s conceivable that if monetary policy is pitted against a slowly reforming government, the Reserve Bank will be the loser.
We are about to find out how adept Kganyago is at dribbling the ball.
• Bisseker is a Financial Mail assistant editor.
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