11 Dec 2013
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We've all heard about how important inflation targeting is for the health of our economies. But inflation targeting is a hotly contested monetary policy instrument. Some question whether it is an appropriate tool to deal with food inflation and oil price hikes. Are they correct to hold this view?
Saliem Fakir Head of the Living Planet Unit at World Wildlife Fund argues that South Africa has perhaps taken a conservative role in the way that it has managed the economy. The relationship between inflation targeting and other "fiscal spend" activities in the treasury needs to be more relaxed for better social outcomes, he contends.
Transcript of Intervew
FAZILA FAROUK: Welcome to the South African Civil Society Information Service, I’m Fazila Farouk in Johannesburg.
We’ve all heard about how important inflation targeting is for the health of our economies. But inflation targeting is a hotly contested monetary policy instrument. In fact, since the 2008 financial crash the debate around inflation targeting has increased. Some economists have gone as far as to say that inflation targeting died when Leman brothers died.
Are they correct to hold this view? But is inflation targeting a one size fits all solution for all economies? What are the implications (of) inflation targeting in relation to emerging economies?
Helping us to make sense of these issues today is Saliem Fakir. Saliem is the head of the Living Planet Unit at the World Wildlife Fund and he also has had a regular column at SACSIS for many, many years.
Welcome to SACSIS Saliem.
SALIEM FAKIR: Thank you very much. It’s a pleasure.
FAZILA FAROUK: Now Saliem increasing numbers of economists have been calling for a debate on inflation targeting. Tell us, firstly what is inflation targeting and what are the elements surrounding the debate on inflation targeting? Why is there such a furor around it at the moment?
SALIEM FAKIR: So let me give a bit of context for how inflation targeting originated.
So, when…in the past when we had the Bretton Woods system, what people called the Bretton Woods System One, most currencies were fixed to the dollar and the dollar was linked to gold. And then in the 70s the gold standard was removed and we moved to more floating currencies. And I think governments tried to look for ways in which to manage currency depreciation or appreciation and they needed something to anchor that on.
So inflation targeting originated actually in, around 1991, when New Zealand’s Central Bank began to implement inflation targeting. And the idea is really to find a mechanism - a monetary mechanism - to maintain price stability in the economy and by price stability I mean finding ways to manage the ebb and flow of inflation because inflation is the result of many factors. And to try to have a long-term view on inflation, what the New Zealand government did is try to create a range in which they could try to manage inflation. So for, example in, South Africa we implemented inflation targeting in 2000 and the idea was to keep a band or a range between 3-6% to manage inflation.
Now post 2008, of course, there was a financial crisis and you know what has happened with the financial crisis. And so, questions began to be raised about the role of monetary policy, the role of central banks…and one of the things that was attacked was inflation targeting because it tended to restrict the way governments spent, and also in the way inflation targeting tended to impose austerity on the way government spent. Because following the crisis people were looking at growing and reigniting growth in the economy.
So, I think there’s a big debate about whether inflation targeting is the right tool. Should central banks be using that or are there other things in the economy that need to be dealt with and is it just about inflation targeting or is there something more deeper that we need to look at?
So, I think in summary the…just to point out as well, I think that there are 195 countries in the world or close to 200. About close to 30 countries implement inflation targeting in the strict sense of the definition. You could argue that some countries like Switzerland and Germany have some form of inflation targeting although they’re not explicit about it. For a long time, the US never explicitly had a policy on inflation targeting until when Bernanke. Ben Bernanke, came on board -- introduced it in 2011.
I would argue that…so the main thing around it is really to recognize that inflation targeting is one of the instruments available for central banks to manage price stability in the economy.
FAZILA FAROUK: And what is the debate around inflation targeting in South Africa specifically?
SALIEM FAKIR: Sure.
There was a period about a year or two ago where the…particularly the unions and so on, questioned the role of the central bank and one of the things that was attacked is inflation targeting. And it might have arisen out of an article that Joseph Stiglitz wrote where he basically said, it’s the end of the era of inflation targeting, if I may sort of crudely summarise that.
And what he was commenting on is - firstly he was pointing to a couple of things - the relationship of central banks and financial crisis and instability. The second thing is the rise in food and food inflation and oil price hikes -- and essentially he was saying that inflation targeting is a useless tool against that.
And it’s partially true because I think whether its inflation targeting or not, I think central banks would struggle to deal with external shocks in the short term. Although I would say that...I would say that his argument is probably political polemic, which was picked up by many people. But he did raise fundamental issues about what do central banks do in a period of crisis? Do they stick to the old tools or do they use unconventional tools to fix problems?
Central banks then have to play a more active role in relationship to the government, which is the treasury. And I think this is really what I think Stiglitz was talking about…and I think what was picked up in the political debate is that the central banks were too conservative. They tried to focus too much on inflation targeting and not look at other factors in the economy. People talk about nominal GDP as another tool, etc.
Other people are talking about completely heterodox tools of, if there’s complete disinflation - in other words if inflation is coming down, is reaching levels of zero, you need to look at other tools to fix the problem. So….
FAZILA FAROUK: So before you move on, is the South African central bank looking at other tools? Does it need to or is it too focused on inflation targeting?
SALIEM FAKIR: I think there’s a – at the moment I think the central bank in South Africa is very focused on inflation targeting because it’s the only thing, it seems to me – that they are probably more risk averse and so don’t want to move into new instruments and tools that perhaps they’re not comfortable with.
So I think there’s a broader conversation to be had because in this country how inflation targeting works is that you’ve got the Minister of Finance who determines the policy, but the actual policy instrument and the independence to apply that at discretionary level is actually the Reserve Bank governor. And so the Reserve Bank governor in a sense would just apply a policy tool or instrument based on the conversation with the Minister of Finance.
So I think there needs to be a two way conversation between the treasury and the central bank in how to deal with underlying issues about lack of growth and so on.
So, some economist would argue that that inflation targeting may be - when you talk about fiscal spend - it imposes a conservative approach within the treasury because if you were to increase the level of fiscal spend and the debt level, that would push inflation up…so it would definitely then create a momentum within the central bank where they would try to – sort of push up the interest rate and try to push down the inflation rate.
FAZILA FAROUK: So crystalize the issue for us. Why should the average person on the street care about inflation targeting?
SALIEM FAKIR: I think there are two main aspects of inflation targeting.
The one is that - is inflation targeting really causing price stability and in that way (is it) helping to tame inflation because inflation would eat at the income of ordinary people? Or, is inflation targeting keeping a constrain on an economy that actually has potential to grow?
And so, you know, the relationship of inflation targeting and other activities of the treasury in terms of fiscal spend and that needs to be more relaxed. And there should be, if you want, more focus on (the) central bank through, probably, dual targets of inflation targeting and also GDP targeting -- a nominal GDP targeting as they call it technically. That leads to a more positive outcome.
I’m not sure the answers are very easy, but I think that it’s fair to say that perhaps we have taken a far more conservative role in the way we have managed the economy. Some people may say its leading to good and other people may say it’s actually leading to lack of growth and that lack of growth is not creating…
FAZILA FAROUK: Where are you on that continuum?
SALIEM FAKIR: I think that – I think there are two things. I think that it’s not just about the role of the treasury, but the way in which the government capacity to activate and enhance economic activity is important. That’s an internal capacity issue within government. The way they spend their money and the spending is going to the right places and the allocation is happening to the right types of activities. I think that relationship between, if you want, more…availability of more money to…be spent in the economy is not just about saying you must increase the debt levels and so the fiscal spend must be higher. But it’s also about the availability of more money to be spent, has to be utilized in the right way. I think perhaps in that middle part is where the biggest challenge lies in South Africa.
The second part of that - you can’t also just have a government having fiscal spend that only benefits private interest. There has to be a balance between an end goal and outcome that benefits a broader society through increase in growth. So there’s obviously the employment subsidy that the government is looking and there are many other ways in which they are trying to do that.
So I think the tricky part is not just about saying we’re going to increase the fold of money available by the treasury for spending, but is that spending going to the right places, is it being used – is it governed well, is it allocated in the right parts of the economy and is it creating the right behavior by other economic agents that there’s no rent seeking and abuse of that where it leads to no positive economic outcome.
FAZILA FAROUK: Thank you very much for joining us at SACSIS Saliem.
SALIEM FAKIR: It’s a pleasure. Thank you very much.
FAZILA FAROUK: And thank you to our viewers and listeners for joining us at the South African Civil Society Information Service. Remember, if want more social justice news and analysis; you can get that at sacsis.org.za.