INFLATION

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INFLATION INFLATION TARGETING
Presented to Parliamentary Sub-Committee on
Finance

• by Dr Azar Jammine
• Director Chief Economist, Econometrix (Pty) Ltd

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CONTRIBUTORS TO INCREASED INFLATION 2002
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INFLATION RATE FORECASTS

• 2001 2002 2003 2004
• CPI Inflation () 5.7 9.4 7.8 5.2
• CPIX Inflation () 6.6 9.5 7.0 5.4
• PPI Inflation () 8.5 14.2 8.1 5.8

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EMERGING MARKETSREAL MONEY MARKETINTEREST
RATES(14/09/2002)
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OPTIONS AVAILABLE ON INFLATION TARGETING

• Abandon Inflation Targeting
• Raise Target
• Change Inflation Measure to Target (from CPIX to
  Underlying i.e. excl. food, housing vehicle
  running costs?)
• Invoke Escape Clause
• Miss the Target

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ABANDON INFLATION TARGETING

• Advantages
• No longer bound to fight inflation vigorously,
  thereby harming short-term growth
• Critics of inflation-targeting placated
• Disadvantages
• Government and Reserve Bank lose credibility in
  fight against inflation
• Risk of Rand coming under pressure with even
  worse inflationary consequences
• Interest rates might have to be raised eventually
  to even higher levels
• Return to boom/bust cycles

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RAISING TARGET

• Advantages
• Meeting targets no longer a pipedream, thereby
  enhancing credibility of process
• Simultaneous retention of target maintains vision
  of determination to fight inflation
• Disadvantages
• Perception of fairweather flexibility to meet the
  prevailing situation may detract from perception
  of commitment to targets
• Small risk of decline in currency with
  concomitant inflation and interest rates
  consequences

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CHANGE OF TARGET MEASURE FROM CPIX

• Advantages
• Exclusion of food fuel would exclude volatility
  caused by factors other than economic policies
• Exclusion of food, fuel housing would render
  CPIX target range of 3 to 6 achievable and
  credible
• Disadvantages
• Relatively ineffective in combating inflation
  more generally because of too many exclusions
• Perception that government acting to please
  itself in fairweather fashion

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INVOKE ESCAPE CLAUSE

• Advantages
• Perception of this being appropriate given
  magnitude of currency depreciation and commodity
  price increases
• Disadvantages
• Perception of lack of commitment to fighting
  inflation when the going gets tough
• Risk of Rand depreciation with concomitant
  inflation and interest rate consequences

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DO NOTHING

• Advantages
• Releases pressure to raise interest rates further
  because of total loss of credibility
• If inflation does fall sharply, government will
  have got away without undue harm
• South Africa would not be only country to miss
  target
• Disadvantages
• Inflation targeting seen to be farcical, leading
  to loss of confidence in commitment to fight
  inflation
• Risk of Rand depreciation with concomitant
  inflation and interest rate increased

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RECOMMENDATION

• Retain inflation targets but increase ranges by
  1
• Change to targeting underlying inflation rather
  than CPIX
• Keep real interest rates positive at all times

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- The End -