Address by Dr Chris Stals, Governor of the South African Reserve Bank, at the second South Africa "Economy, Investment and Trade Conference" arranged by Cityforum Limited, London. 1. The objectives of monetary policyThe main objective of monetary policy in South Africa is to establish a stable financial environment in support of sustainable real economic growth over the medium and longer term. The South African Reserve Bank believes that financial stability may not provide a guarantee for economic growth, but it certainly is an important precondition for the maximum employment of the resources of the economy, including the labour force. Although low (or even zero) inflation is regarded as the ultimate measure of financial stability, the monetary policy model in South Africa targets the intermediate objective of changes in the money supply. For this purpose, guidelines are set by the Reserve Bank at the beginning of each calendar year for an acceptable rate of growth in the M3 money supply. For 1995, guidelines of 6 to 10 per cent were decided on with the intention of providing for real growth in the economy of between 3 and 4 per cent, and the recognition of a rate of inflation of 9 per cent in 1994. The intention was therefore that monetary policy should exert further downward pressure on inflation during the course of 1995. Money is created in South Africa mainly through the extension of credit by banking institutions. In setting guidelines for an acceptable rate of growth in the money supply, the Reserve Bank indirectly provides indicative limits for the growth in the total claims of the banking sector on the private sector or, viewed from a different angle, for the increase in the total indebtedness of the private sector to the banking sector. The monetary model as applied in South Africa therefore gives the Reserve Bank a vested interest in the total credit extension of the banking sector. The Reserve Bank can influence the amount of bank credit extension either by influencing over-all liquidity in the banking sector, that is, by influencing the supply of credit, or by influencing the demand for credit emanating from the private sector. Liquidity in the banking sector can be influenced through various operational instruments such as changes in minimum cash reserves for banking institutions, open market-operations and short-term money market interventions through swaps and repurchase transactions. The demand for bank credit is to an important extent interest rate driven. By influencing the general level of interest rates, the Reserve Bank can exert some influence on the total demand for credit, and therefore on the money supply. The main operational instrument in this case will normally be the Bank rate, that is the rate at which the Reserve Bank is prepared to make loans to banking institutions at the discount window. In pursuing its money supply objectives, the Reserve Bank must of course also take account of fiscal policy, and in particular of the magnitude of the deficit before borrowing in the budget of the government sector, and in the sources used for funding the deficit. Money supply targets can easily be frustrated by inflationary financing of the budget deficit. In South Africa, good co-operation between the Reserve Bank and the Treasury is constantly on guard against this danger.The monetary policy model is influenced in various ways by the international financial relations of the country. Changes in the gold and foreign exchange reserves have a profound influence on the liquidity of the banking sector; net inflows or outflows of capital link South African interest rates to rates in the rest of the world; and the stability of the exchange rate of the rand presents an alternative measure for the value of the currency. The Reserve Bank therefore also has a vested interest in the level of and changes in the official foreign reserves and in the exchange rate of the rand, and in changes in international interest rates, particularly in the case of countries with whom South Africa maintains close financial relati