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South African Reserve Bank

Publication Detail 

September 1998 - Article - The cost of inflation
Publish Date:
M.M. Smal
Quarterly Bulletins Articles and Notes

Inflation undermines the role of money as a unit of account and as a monetary standard. This contrasts with most other activities where, once a standard is chosen, every effort is made to ensure that it is maintained (Konieczny, 1994). Inflation creates confusion because, while it is easy to recognise that one rand buys fewer goods and services, it is much more difficult to determine what it is worth and what it will be worth. The former problem deals with the role of money as a means of exchange, whereas the latter affects the role of money as a store of value. It is not surprising that nowadays high inflation is generally recognised internationally by monetary and fiscal authorities as undesirable and bad for national economies. There is a growing appreciation worldwide that it is not possible to achieve long-term growth and employment by tolerating, let alone fuelling, high rates of inflation.

In South Africa, the De Kock Commission in its final report in 1985 states that “in the long term the primary objective of monetary policy should be the maintenance of reasonable stability of the domestic price level.” This important objective of monetary policy is also recognised in the South African Reserve Bank Act. In his first Governor’s Address to the Bank’s shareholders in August 1989, Dr C. L. Stals stated that the Bank’s primary mission is to protect the value of the rand, i.e. to combat inflation. Since August 1989 the Reserve Bank’s policy actions have placed a high priority on counteracting the forces of inflation in the South African economy (Meijer, 1990: 31).

From time to time, policy makers, and particularly the monetary authorities, have been accused of contributing to the sub- optimal performance of the South African economy through their actions to reduce inflation. Although there is a price to be paid for reducing inflation, policy makers have to face the question of whether that price would not be lower than the price that would ultimately have to be paid for allowing high, and often increasing, inflation. The desire to reduce inflation reflects a judgment that inflation imposes significant costs on the community. The first argument for the case of price stability would be to identify the cost of inflation itself. Unfortunately, many of the social costs of inflation are difficult to calculate accurately. Even the economic costs of inflation are not easy to quantify.

These costs are usually spread over an extended period and are not as evident as the costs of price stabilisation policies, which are normally confined to a relatively short period. Moreover, the costs of inflation constantly change over time as economic behaviour adapts to inflation. Given the diversity of the types of costs that have been identified as stemming from inflation, no specific empirical research has comprehensively quantified all these costs. However, the analysis of empirical evidence on the nature of the relations among inflation, uncertainty, relative price variability and output growth has made substantial progress in the 1990s. Although consensus cannot be said to exist, there are now firm indications that the gross benefits of low inflation are larger than was thought at the beginning of the 1990s (O’Reilly: vii).

It is not the purpose of this article to undertake an extensive empirical analysis to calculate the exact cost of inflation in South Africa. Instead, a summary is provided of some of the costs of inflation, illustrated with graphs and tables. The next section describes the measurement and historical development of inflation in South Africa. Then the main changes in attitudes to inflation are discussed, and the most important costs of inflation dealt with. The article concludes that inflation creates uncertainty about the future, that there are costs in having to cope with inflation and that “living with inflation” is no solution for sustainable higher economic growth or development. It highlights the need to ensure that inflation does not become a permanent feature of the economy.

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