BRIAN KANTOR: Reserve Bank is keeping a lid on growth

Central banks nearly everywhere have to play catch-up with highly elevated inflation rates — of their own making. The stimulus they provided in the form of rapid growth in their money supply, combined with generous income relief from their treasuries during the Covid-19 lockdowns, have proved too much of a good thing for spending.

The unexpected weight of extra spending has to some degree overwhelmed supply chains, putting further pressure on prices. The invasion of Ukraine and economic war on Russia have further shocked the energy and food markets, leading inflation higher.

The problem for households that undertake most of the spending in any economy — as much as 70% in the US — is that higher prices for essentials such as food and transport absorb spending power and disposable incomes. Higher prices have their causes — they also have their negative effects on the ability to spend.

Higher prices that restrain demand can help make higher inflation rates a temporary rather than permanent condition. It takes continuous increases in demand, stimulated by further rapid growth in the money supply to fund persistently large fiscal deficits, to sustain continuous increases in inflation at double-digit rates. Africa is full of such case studies. A fiscal deficit theory of money creation and inflation makes every sense.

A high degree of central bank caution in responding to what may well be a temporary burst in inflation is called for in the developed world to help negotiate any transition back to permanently lower inflation without disrupting its real economies. It appears that the debt markets in the US have only marginally raised their estimates of inflation, in the belief that the Federal Reserve will succeed in meeting its inflation targets, at least in the long run.

Clearly inflation expectations are not simply recent inflation rates extrapolated — they are rationally based on a theory of inflation. The Reserve Bank believes in the danger of second-round effects of inflation — inflation extrapolation — whatever the cause: reduced supplies or excess demand. Hopefully, it has noticed the failed test of this theory of self-fulfilling inflationary expectations.

The SA economy has been in a different space. Unlike almost everywhere else the money supply and bank lending have grown only slowly since 2020, as has spending. The Bank did not do quantitative easing. Government spending on income relief was restrained by comparison to the rest of the world, and government revenue surprised on the upside, helping contain the fiscal deficit in 2021. The growth in central bank money, and money broadly defined, slowed down sharply in 2021. It picked up some welcome momentum in the first quarter of 2022.

Accordingly, by Bank admission there is no sign or expectation of excess spending pushing prices higher. Prices are rising slightly faster than before because of the recognised supply-side shocks to energy and food prices. Only in 2023 is the economy expected to approach its assumed (very dismal) annual GDP growth potential of 1.9%.  Further depressing demand with higher interest rates will have little effect on inflation given the prevailing and temporary supply-side shocks on the price level. It is more likely to depress growth rates.

The Bank’s monetary policy committee says it “will seek to look through temporary price shocks and focus on potential second-round effects and the risks of deanchoring inflation expectations”. Unfortunately, its actions indicate it has chosen not to do so.

The Bank is right to argue that it should not be held responsible for the structural weaknesses of the economy, but it can be held responsible for repressing demand, money supply and bank credit growth to rates that make even slow growth in demand impossible, with little effect on inflation.

The thrust of monetary policy is best revealed by its effects on money supply and credit growth — not by the relationship between interest rates and inflation. By this measure monetary policy in SA has not been accommodating of faster growth and is likely to become less so.

• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.