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Monetary Policy

The SARB fulfils its constitutional mandate to protect the value of the rand by keeping inflation low and steady.

 

Monetary policy is the means by which central banks manage the money supply to achieve their goals. The SARB uses interest rates to influence the level of inflation.

National Treasury, in consultation with the SARB, sets the inflation target, which acts as a benchmark against which price stability is measured. The SARB then independently makes monetary policy so as to achieve this target. 

The basic aim of monetary policy is to determine how much money an economy should have in circulation. The monetary policies of countries may differ, but most major economies aim for low and stable inflation, and have publicly announced inflation targets. 

To protect the value of the rand, the SARB uses inflation targeting, which aims to maintain consumer price inflation between 3% and 6%. The value of the currency is therefore protected relative to domestic consumer prices.

Monetary policy is implemented by setting a short-term policy rate – the repo rate. This affects the borrowing costs of the financial sector, which, in turn, affect the broader economy. The repo rate is so called because banks give the SARB an asset, such as a Government bond, in exchange for cash. They can later repossess (repo) that asset at a lower price, which reflects the interest they paid (i.e. the repo rate) to have the cash.

Inflation Targeting Framework

South Africa formally introduced inflation targeting in February 2000. This is a framework in which the central bank uses monetary policy tools, especially the control of short-term interest rates, to keep inflation in line with a given target. South Africa's inflation target range is 3−6%. Before adopting the inflation-targeting framework, the SARB used several different frameworks, including exchange rate targeting and money supply targeting. The inflation-targeting approach has been more successful. It has permitted a more realistic alignment between the SARB’s tools and objectives. It has also enhanced transparency and accountability by giving the SARB a clear and publicly visible objective. 
 

Inflation is an increase in the general price level of an economy.

Inflation involves much more than price shocks such as higher petrol prices. Most economies are inflating all the time: every year, prices are generally higher than they were the year before. For instance, in South Africa, consumer prices rose by 65% between 2010 and 2020, at an average annual inflation rate of 5.2%. Other countries had different inflation rates over the same period. For example, inflation in the United States averaged 1.8%; in Turkey it was nearly 10%. This shows that inflation dynamics reflect a country’s economic structures and policy choices.

In South Africa, the standard measure of inflation is Statistics South Africa’s (Stats SA’s) consumer price index. This index represents a typical basket of goods and services used by South African households, comprising everything from lottery tickets and petrol to life insurance. Stats SA monitors these prices throughout the year, and reports any changes each month.

 

Monetary economists identify three basic causes of inflation: demand, supply and expectations.

  • Demand-side inflation: When consumers spend more money, prices tend to rise faster. By contrast, when consumers are under pressure and spend less, prices rise more slowly. 

  • Supply-side inflation: Inflation tends to decrease if it becomes cheaper to produce a good or service. For example, globalisation made it cheaper to produce manufactured goods such as clothes and electronics. Conversely, inflation could increase if it becomes more expensive to produce a good or service. For example, a drought raises food prices. 

  • Expectations: This is the most abstract cause of inflation, but also the most important, especially for central banks. All countries experience supply and demand shocks, but different countries tend to have markedly different inflation rates. The reason for this is expectations. People who set prices and wages factor inflation into their decisions. For instance, employees usually expect a cost-of-living increase each year. Landlords adjust rental rates. Schools raise fees. This logic applies throughout the economy. When inflation expectations get out of control, demand can be very weak but prices still rise rapidly. (This is called stagflation).

These three drivers of inflation interact in complex ways. For example, a rise in fuel prices can increase inflation (supply-side shock). But if workers and firms then change their inflation expectations in response to the fuel price shock, inflation may increase due to expectations.

Inflation is fundamentally a monetary phenomenon. Prices can fluctuate for reasons other than monetary policy, but a sustained change in the price level requires more money in circulation, and therefore the consent of the central bank which prints it.

Printing money is perhaps the most obvious cause of inflation, responsible for all historical hyperinflations. But except for extreme cases, changes in the amount of money in circulation do not predict inflation very well. For this reason, economists now rarely study money supply data to understand inflation, focusing instead on the factors described above.

 

Monetary policy in South Africa aims to achieve and maintain price stability in the interest of balanced and sustainable economic growth and transmits to the economy through different channels.

Consider a scenario where the central bank raises the interest rate. This will do at least four things:

First, it will increase costs for borrowers with floating interest rate debt (such as the interest rate on home loans). It will also promote saving and discourage borrowing. Together, these effects weaken demand, reducing price pressures in the economy. (This is often called the savings and investment channel).

Second, a higher interest rate will tend to strengthen the rand’s exchange rate by improving returns on rand-based investments. In turn, a stronger rand reduces the price of imported goods. (This is the exchange rate channel).

Third, by raising rates, the central bank signals a commitment to reduce inflation. Price and wage setters will factor this expected reduction into their wage and price decisions. (This is the inflation expectations channel).

Fourth, higher interest rates will affect asset markets by, for example, moderating house prices. This can reduce the wealth of asset owners and cause them to reduce their purchases, slowing the economy. (This is known as the wealth channel).


Figure 1: Transmission mechanism 
Transmission mechanism

The core idea of inflation targeting is that monetary policy has only temporary effects on growth, but permanent effects on prices.

Inflation targeting grew out of two theoretical breakdowns. In the 1970s, many central banks accepted higher inflation because they believed it would boost economic growth, but instead it resulted in stagnant growth and higher inflation (i.e. stagflation). ‘Monetarist’ approaches, which became influential in the 1980s, also failed, as central banks realised that changes in money supplies were only loosely related to the outcomes people cared about, such as inflation. Inflation targeting provided an elegant solution to the flaws of both these frameworks. A number of countries, such as Brazil and the United Kingdom – and to some extent South Africa – adopted inflation targeting due to the failure of a third policy: managing exchange rates. These policy experiences showed that inflation was more controllable, and more relevant, than other variables central banks had tried to target.

In practice, inflation targeting has demonstrated several other advantages. It has made central banks more accountable, because their performances can now be assessed against clear metrics: their inflation targets. It has also made them more transparent in their communications. When the public understands what monetary policy is trying to achieve, and trusts the central bank to deliver, success is more likely.

Furthermore, although inflation targeting was built on the premise that monetary policy cannot permanently affect ‘real’ variables such as growth and employment, the framework has allowed policymakers to respond better to cyclical fluctuations in economic performance. Credible monetary policy stabilises inflation, allowing central banks to lower rates during periods of economic weakness. The claim that inflation-targeting central banks ignore growth is therefore incorrect.

 

South Africa uses an inflation target of 3–6% for the headline consumer price index calculated by Stats SA.

The target is set by the Minister of Finance, in consultation with the Governor of the SARB. Since 2017, the Monetary Policy Committee has emphasised that it would like to see inflation close to the 4.5% midpoint of the 3–6% target range.

The target is:

  • Continuous: Policy should aim for inflation to be within the target range at all times.
  • Flexible: Temporary deviations from the target are acceptable provided that inflation returns to the target range over a reasonable period (usually one or two years). This flexibility means that policy does not have to offset the price effects of shocks, such as fuel price increases, provided they are purely temporary.
  • Forward-looking: Policymakers are not required to make up for missing the target in the past, but they are expected to ensure that inflation always returns to the target.

 

The Monetary Policy Committee (MPC) meets six times a year to set the repo rate.

The MPC consists of up to seven members, including the Governor of the SARB, the three deputy governors and senior officials appointed by the Governor.

A typical meeting opens with presentations by senior officials covering developments in the global and domestic economy and financial markets, as well as the economic outlook. The staff economists then leave and the MPC members decide on the repo stance and prepare a statement. Finally, the Governor delivers this statement at a televised press conference, which includes a question-and-answer session with journalists.

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CURRENT REPO RATE

Next due: to be updated by SARB

CURRENT INFLATION RATE

NOMINAL EFFECTIVE EXCHANGE RATE

SECTIONS

Monetary policy committee
Monetary policy implementation

 

UPCOMING ANNOUNCEMENTS

21January MPC 2021
25 March MPC 2021
22 July MPC 2021
23 September MPC 2021
18 November MPC 2021

 

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