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 historical disappointments. The first was the stagflation experience of the 1970s and 1980s, when a wide range of central banks accepted higher inflation in the hope that this would boost economic growth, but ended up with stagnant growth and higher inflation (i.e. stagflation) instead. The second was the failure of the ‘monetarist’ approaches, when central banks discovered that changes in money supplies were only loosely related to the variables people really cared about – such as inflation. Inflation targeting provided an elegant solution to the flaws of both these other frameworks. In the South African case, as for several other countries (e.g. Brazil and the United Kingdom), the trigger for moving to inflation targeting was actually the failure of a third policy, namely that of trying to manage exchange rates. The unifying theme across these experiences was that inflation turned out to be more controllable, and more relevant, than other variables central banks had tried to target.

In practice, inflation targeting has demonstrated a number of other advantages. It has made central banks more accountable, because their performances can now be judged against clear metrics: their inflation targets. It has also made them more transparent. This is because communication itself has become an important policy tool: when the public understands what monetary policy is trying to achieve, and trusts the central bank to deliver, that in itself makes success more likely. 

Finally, although inflation targeting was constructed on the premise that monetary policy cannot permanently affect ‘real’ variables such as growth and employment, the framework has allowed policymakers to respond more forcefully to cyclical fluctuations in economic performance. With credible monetary policy, inflation becomes very stable, allowing central banks to lower rates during periods of economic weakness. Although inflation targeters are sometimes caricatured as ignoring growth, in practice, inflation-targeting central banks almost universally include cyclical fluctuations in growth and employment in their decisions.

South Africa uses an inflation target of 3–6%, for the headline consumer price index calculated by Stats SA. This target was introduced in 2000. Since 2017, the MPC has emphasised that it would, in general, like to see inflation close to the 4.5% midpoint of the 3–6% target range.

The target is continuous, meaning policy should aim for inflation to be within the target at all times. (It is not, for example, about achieving an average inflation rate over a given period, such as a year.) The target is also flexible, which means that 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 policy does not have to create real economic activity by using large interest rate changes to try and eliminate the effects of temporary shocks, such as fuel prices increases. Finally, inflation targeting is always forward-looking: policymakers are not required to make up for missing the target in the past, but they are expected to ensure inflation is always heading back to the target.

The inflation target is set through a process of consultation between the Minister of Finance and the Governor of the SARB.