In the late 70’s, Paul Volcker, then Federal Chairman under Jimmy Carter (later under Ronald Reagan), was determined to bring inflation down, even at a heavy price. He tightened monetary policy, sending interest rates sky high, with mortgage rates going above 18 percent. What followed was a severe recession that drove unemployment to double digits . During Volcker’s monetary onslaught, there were many congressional proposals, backed by members of both parties, to curb the Federal Reserve’s power, lower interest rates or fire Volcker.

The Reagan Treasury Department under its head Donald Regan and the Republican Senate majority under its head Howard Baker were openly and publicly opposed Paul Volcker’s tight-money fight-inflation-first policy. Volker’s obsession with inflation-targeting reduced consumer spending and increased joblessness. The unemployment rate went from 6.3 percent to 7.8 in four months from March to July. Although Volker’s Keynesian economics promised to stabilise the economy at levels of low inflation and high employment, the social costs that would follow, high unemployment and lost output and lost jobs was too great.

The same cry followed Alan Greenspan, the next Fed Chairman after Volker,  who many congressman wanted to have a more expansionary fiscal policy and to end inflation targeting, which they blamed for higher interest rates that had risen 500 basis points in over a year. Many economists outside the government said that the Fed and the Administration were on a collision course on economic policy because the tight monetary policy promised by the Fed would not allow for the relatively strong economic growth that the President had forecast.

Here in South Africa, particularly during Tito Mboweni’s tenure, the Congress of SA Trade Unions (Cosatu) had criticised the central bank’s determination to tame inflation through interest rates, demanding the removal of inflation targeting and/an expansion of the South African Reserve Bank (SARB) Mandate. Mboweni’s stubborn inflation targeting obsession had put him on a collision course with those who said it was better to have higher prices with more people working than lower prices with fewer people working. Cosatu managed to convince the ANC in Mangaung 2012 to take a resolution on SARB. The ANC resolution on Economic Transformation at the 53rd National Conference of the ANC in 2012 said:

“South Africa requires a flexible monetary policy regime, aligned with the objectives of the second phase of transition. Without sacrificing price stability, monetary policy should also take account of other objectives such as employment creation and economic growth. In this regard, government should engage with the new wisdom developing on macroeconomic policy around the world in response to past failures and the global crisis.”

The appointment of Gill Marcus brought renewed hope as she also made statements that were sympathetic to the importance of other indices. It however would take a public protector, Busisiwe Mkhwebane, on Monday, 19 June 2017, to finally grant this enduring request, as part of her remedial actions. The Public Protector recommended that Section 224 of the Constitution be amended to include within the mandate of the Reserve Bank the responsibility to ensure that the socio-economic well being of the citizens are protected, in addition to its mandate of protecting the currency and ensuring price stability. The backlash she has gotten for this is curious.

Inflation targeting refers to a monetary policy framework where the central bank explicitly and publicly declares a target inflation (or price) quantum that it will use the monetary policy instruments to achieve and maintain. The SARB conducts inflation targeting by changing short-term interest rates to manipulate economic activity in order to maintain inflation within the SARB pre-announced “target” range. A major shift in the conduct of monetary policy occurred during the 1990s with an emphasis on maintaining price stability. The move to inflation targeting on the back of an overwhelming faith in the ‘NAIRU ideology’ marked the final stages in the evolution of an abandonment of full employment. This means, historically, the role of the central bank has always been brought, with full employment as its primary role.

The modern policy framework is in contradiction to the practice of governments in the post World War II period to 1975 which sought to maintain levels of demand using a range of fiscal and monetary measures that were sufficient to ensure that full employment was achieved. In Australia for example the RBA was constituted to maintain full employment as one of its three policy goals.

In their paper “The real problem with inflation targeting” William Mitchell and Anthea Bill cast doubt on claims that inflation targeting has been a success. Key non-inflation targeting economies, such as Japan and the US, have official interest rates of 0.001 per cent and 1.25 per cent, respectively, compared to South Africa’s rate of 5.25 per cent and Australia’s 2.2%.

Mitchell and Bill’s main conclusion is that inflation targeting does not generate significant improvements in the real performance of the economy. However, they argue that the “ideology” of inflation targeting does damage the real economy because it embraces a bias towards passive fiscal policy which in their view locks in persistently high levels of labour underutilisation.

Disinflationary monetary policy and tight fiscal policy can bring inflation down and stabilise it but it does so at the expense of creating and maintaining a buffer stock of unemployment. The policy approach is seemingly incapable of achieving both price stability and full employment (Mitchell, 2001a).

There are well published problems with inflation targeting as the sole responsibility of a Central Bank. One is that interest rates as a tool for dealing with inflation is limited. When we have a cost-push inflation, causing a temporary rise in inflation say due to rising oil prices, to target a particular percentage inflation would require higher interest rates, which leads to lower growth.

Secondly, central banks start to ignore more pressing problems. For example, ECB is setting monetary policy to keep inflation in the Eurozone on target. Yet, the ECB seems unwilling to act on the significant increase in unemployment. In 2011/12, the ECB seemed remarkably unconcerned about the Eurozone’s slide into a double-dip recession. Rather than trying to prevent a prolonged slump, they are fixated on the importance of low inflation. Unemployment in Spain reached 25%, but there was no monetary stimulus in the Eurozone because the ECB was worried about inflation at 2.6% – this is giving low inflation too much priority in times of a recession.

Inflation above targets can impose costs on the economy such as uncertainty, loss of competitiveness and menu costs, but arguably these costs are much less significant than the social and economic costs of mass unemployment. It’s also very important to realise that low inflation doesn’t mean the economy has an underlying stability. Low inflation can disguise an asset and banking boom and bust. Targeting inflation alone can lead to a sub-optimal response.

Even at a time when South Africa’s economy was growing consistently, the economy remain stubborn at over 25% and the Reserve bank was unbothered.

Why the constitution in South Africa is so specific on the role of the Reserve Bank in the first place is curious, particularly at a time it was written given the European dynamics.

Mkhwebane has fired the first salvo, Parliament must adhere or take it for review. We have full confidence in Mogoeng Mogoeng. DM