Inflation targeting is a framework in which the central bank employs monetary policy tools, particularly short-term interest rate management, to keep inflation within a set range. The inflation goal range in South Africa is 36%.
The SARB used numerous other models before adopting the inflation-targeting methodology, including exchange rate targeting and money supply targeting. The inflation-targeting strategy has shown to be more effective. It has allowed for a more realistic alignment of the SARB’s tools and aims. It has also improved transparency and accountability by providing the SARB with a defined and publicly visible goal.
Why is inflation targeting used?
The core premise of inflation targeting is that monetary policy has only short-term effects on growth but long-term effects on prices.
Two historical disappointments prompted the development of inflation targeting. The first was the stagflationary experience of the 1970s and 1980s, when a wide range of central banks accepted higher inflation in the aim of boosting economic growth, but instead experienced sluggish growth and rising inflation (i.e. stagflation). The second failure was the failure of’monetarist’ techniques, when central banks recognized that changes in money supply were only tangentially related to the variables that people truly cared about, such as inflation. Inflation targeting provides an elegant solution to both of these other theories’ shortcomings. In South Africa, as in several other countries (including Brazil and the United Kingdom), the failure of a third policy, namely the attempt to manipulate currency rates, provided the impetus for turning to inflation targeting. The common thread in these instances was that inflation proved to be more controllable and meaningful than other variables that central banks attempted to target.
In practice, inflation targeting offers a variety of additional benefits. It has increased the accountability of central banks because their performance can now be measured against specific metrics: their inflation targets. It has also increased their transparency. This is due to the fact that communication has become a key policy tool: when the public understands what monetary policy is attempting to achieve and trusts the central bank to deliver, success is more likely.
What is the inflation goal?
For the headline consumer price index calculated by Stats SA, South Africa uses an inflation goal of 3-6%. This goal was established in the year 2000. Since 2017, the MPC has emphasized that it prefers to see inflation near the 4.5% midpoint of the 3-6% target range.
The objective is continuous, which means that policy should strive to keep inflation within the target at all times. (It is not, for example, about achieving a certain period’s average inflation rate, such as a year.) The target is also flexible, which implies that temporary deviations from it are permitted as long as inflation returns to the target range within a reasonable time frame (usually one or two years). Because of this flexibility, policy does not have to generate actual economic activity by utilizing substantial interest rate changes to try to offset the effects of temporary shocks like fuel price hikes. Finally, inflation targeting is always forward-looking: policymakers are not expected to make up for previous missed targets, but they are expected to ensure that inflation always returns to the target.
