The SA Reserve Bank is one of the country’s strongest and most trusted institutions, and its intentions with the new 3% inflation target are grounded in protecting the public, especially the poor. However, this new target makes monetary policy conduct more delicate than before, and brings with it the good, the bad and the ugly.
The first good is the timing. Inflation has been falling since the shock of the Russia-Ukraine conflict pushed it above 8%. By lowering the target just as inflation was dropping to about 3% and allowing interest rates to ease, the Bank managed to implement the change without slamming the brakes on the economy.
The second good is that a lower target should mean lower inflation and lower interest rates over time. This should bring real relief to households struggling with the cost of living and make borrowing less punishing. Lowering the target is a direct protection for poor people whose budgets are mainly used for basic needs such as food, electricity and transport.
The third good, which is often ignored and less understood, is expectations. The Reserve Bank must remain credible by making people trust that it can keep inflation low. When households and businesses do not trust this, they act in ways that push prices up. Stellenbosch University’s Bureau for Economic Research (BER) has been measuring these expectations since 2001 across households, businesses, unions and analysts. Its latest findings show confidence that 3% is possible.
Problems
However, there is another side to this story, since the uncomfortable truth is that SA is not growing fast enough for a 3% target to be effortless. Countries that hold inflation at 2%-3% usually grow at about 4% a year (India and the US, for example). SA’s growth is nearer 2%. Weak growth makes a strict target harder to maintain. It also makes it more likely that in the event of higher inflation, interest rates will stay high for longer, which strains investment, borrowing and spending. The target is ambitious, but the economy beneath it is sluggish.
Then comes the global chaos factor. The world has become unpredictable, especially with political leaders such as US President Donald Trump, who thrive on shock and confusion. A sudden geopolitical disruption can push inflation from 3% to 6%, or even 10%, in a short time.
This happened in the early stages of the Ukraine-Russia war in early 2022. If that happens again, the Bank would be forced to raise interest rates more aggressively than normal. And if it is unable to bring inflation down to its target, confidence in the institution would wobble. When that confidence slips, inflation rises and the economy will eventually slip as well.
A frightening example is that of Brazil, which similarly lowered its target to 3% last year. This year, inflation in Brazil climbed from about 4% in May to more than 5% by October. Even though this increase was not large, it was above its new target, and the Brazilian Reserve Bank had to hike interest rates seven times in the past six months, doubling rates from 7.5% to 15%. Despite these efforts, inflation in Brazil is still above its target.
Poor could suffer most
There is another ugly truth. A low inflation target is supposed to help poor households, but if it misfires, they also suffer the most. Many poor households do not know what the Reserve Bank does or how its decisions affect their lives. They are not equipped to shield themselves from higher borrowing costs. If the target fails, the very people it is meant to protect will pay the greatest price.
We can only hope that a sudden global shock, a dip in confidence or another surge in prices doesn’t turn order into chaos. So we will keep our fingers crossed and hope expectations stay steady and global winds behave.
• Phiri is an associate professor in the economics department at Nelson Mandela University.
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