Reserve Bank governor Lesetja Kganyago says advanced economies would do well to look to the south for lessons as central bankers around the word grapple with high inflation and debt costs.
In an article published in the March edition of the IMF’s Finance & Development magazine, Kganyago said emerging markets such as SA had for some time been dealing with inflation drifting above targets, unlike developed countries whose monetary policy and public dialogue about economic policy had for decades centred on zero interest rates and low inflation.
Emerging markets also had to deal with demands from government and radical voices for lower interest rates to lift short-term economic growth, and to finance unsustainable fiscal positions, he said.
“Now, as the economic conversation in advanced economies changes to address higher inflation, emerging markets have something to offer,” Kganyago said.
“Emerging market central banks have ample experience dealing with these conditions, including the political pressure that often follows policy tightening.”
Expansionary monetary and fiscal policy that had been required to support households and businesses during the pandemic was upended in February 2022 when Russia invaded Ukraine. That led to higher food and energy prices and pushed inflation in developed countries to levels last seen in the 1970s.
In an attempt to control runaway inflation, which far surpassed the upper bracket of monetary policy authorities’ target ranges, central banks front-loaded interest rates, rapidly increasing borrowing costs.
As a result, countries with high public debt faced increasingly larger debt-servicing commitments — with immediate and severe fiscal implications for their governments.
Princeton University economics professor Markus Brunnermeier said persistently high inflation means there is now a clear trade-off between monetary policy that tries to reduce aggregate demand by raising interest rates and one that aims to ensure financial stability.
Advanced economies also have to deal with the change of the “nature and frequency of shocks”, Brunnermeier said.
“Historically, shocks were mostly from increases or decreases in demand — with the prominent exception of the supply shocks during the so-called stagflation [high inflation and unemployment and a sluggish economy] of the 1970s. Now there are many shocks: demand versus supply, specific risks versus systemic risks, transitory versus permanent,” he said.
“It is difficult to identify the true nature of these shocks in time to respond. Central bankers need to be more humble.”
Brunnermeier said central banks face further new challenges in the interaction between monetary and financial stability, whose dynamics closely resemble the patterns in emerging markets.
In his article, Kganyago said that for many years, central bankers in developed economies believed the textbook response to supply shocks was “don’t respond because the shock will dissipate”.
“I have spent more time trying to gauge the impact of supply shocks, and communicating how we distinguish between transitory and persistent effects, than I have managing demand-side pressures. Many emerging markets have had similar experiences,” Kganyago said.
Part of the problem is that even with moderate rates of inflation, price and wage setters learn to track inflation and to index their prices, he said.
That means if central banks do not respond to shocks in a timely way, price pressures expand and inflation expectations shift. That leaves policy further behind the curve, so that temporary shocks end up having lasting effects, he said.
Emerging economies exhibit more indexation and less tolerance for real income losses.
“Many emerging market economies have introduced robust inflation-targeting frameworks to better shape inflation expectations, and these have generally worked well, creating policy flexibility,” Kganyago said.
Advanced economies had mistakenly assumed that fiscal and monetary policy do not overlap, he said.
Brunnermeier said central bankers in developed economies were surprised to find themselves operating in an environment of high private debt, depressed risk premiums on financial assets, distorted price signals, and a private sector heavily reliant on the liquidity that central banks provide during a crisis.
A decade-and-a-half ago, central banks’ twin goals of stimulating economic activity and financial stability through unconventional policies had coincided, he said.
“Now, there are clear trade-offs between inflation management and financial stability, because interest rate hikes to fight inflation threaten to destabilise financial markets,” Brunnermeier said.
“But any emerging market policymaker will tell you monetary policy can be distorted by fiscal policy.”
Kganyago said the increase in concern about fiscal dominance bore that out — not least as major central banks focus on the legacy of quantitative easing and other policies that boosted their holdings of state debt.
“Because of balance sheet concerns, it is even more critical that central bank mandates remain simple and direct,” Kganyago said.
“To achieve good outcomes, countries need a broader macroeconomic strategy that delivers other key outcomes, especially fiscal sustainability. Without such a strategy, central banks cannot, by themselves, ensure a growth-friendly environment.”
Kganyago said improved co-ordination between sustainable fiscal policy and monetary policy would create important synergies, reducing the impact of supply shocks, keeping the cost of financing governments low, and taking inflation off the list of concerns of households and firms throughout the emerging world.
“Central banks should reiterate their strategic goals — clearly, patiently and backed by good evidence,” he said.
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