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Date : 24/03/2004
Source: South African Reserve Bank
Title: T Mboweni: International Investors Conference


THE MONETARY POLICY FRAMEWORK OF SOUTH AFRICA: ADDRESS BY MR TT MBOWENI, GOVERNOR OF THE SOUTH AFRICAN RESERVE BANK, AT THE INTERNATIONAL INVESTORS CONFERENCE, Sun City, 24 March 2004

1. Introduction

The main task of macro-economic policy is the promotion of sustainable high economic growth, the creation of employment opportunities, the containment of inflation, improvement of the living conditions of all the residents of a country, and the elimination of unjustifiable discrepancies in the distribution of income amongst our people. These economic objectives can best be obtained amongst other things in a stable financial environment. Financial instability is a major obstacle in the fulfilment of this task. Stable financial conditions should be maintained throughout the various phases of the business cycle to attain maximum economic development.

2. Primary objective of monetary policy

The role of the South African Reserve Bank (SARB) in this process is to achieve and maintain price stability and to develop and supervise a healthy banking sector. This objective is spelled out in both the Constitution of South Africa and in the SARB Act. In section 224 of the Constitution and section 3 of the SARB Act it is stated that the primary objective of the Bank is to protect the value of the currency of the Republic in the interest of balanced and sustainable economic growth. This, in our view, means price stability. These laws therefore recognise that only by protecting the currency can balanced and sustainable economic growth be achieved. It is believed in the Bank, and indeed in most other central banks in the rest of the world, that the potential growth rate of an economy and the optimum creation of employment opportunities can only by attained under stable financial conditions. By fulfilling this primary objective, the SARB will be making its contribution to sustainable high economic growth in South Africa.

Section 224(2) of the Constitution determines further that the SARB, in pursuit of its primary objective, must perform its functions independently and without fear, favour or prejudice. Regular consultation must, however, take place between the Minister of Finance and the Governor of the SARB. In addition to this legal requirement, section 10(2) of the SARB Act clearly states that "the rates at which the Bank will discount or rediscount the various classes of bills, promissory notes and other securities shall be determined and announced by the Bank from time to time". This gives the Bank the right to determine the official rate, or as it is now called the repo rate. These laws therefore provide the executive management of the Bank with complete instrumental independence, with the one precondition that regular consultation should take place with the Minister of Finance. The Bank can accordingly perform its work in an autonomous manner.

Having established that the task of the Bank is the achievement and maintenance of price stability, what does the term price stability convey? In the economic literature price stability is normally regarded as a situation wherein changes in the general price level do not materially affect the economic decision-making process. Although relative price movements still have an impact on production, consumption and investment, the rate of inflation in such conditions is no longer an important factor in the decisions taken by producers, consumers and investors.

Price stability is heavily dependent on stability in the financial sector. The Bank has accordingly also been tasked to promote the soundness and management of domestic banks through the effective application of international best practise in the regulatory and supervisory area. The objective of banking supervision is to ensure that banks manage their risks in such a way that systemic risk in the banking sector is minimised, thereby ensuring the safety of depositor's money. It is aimed at promoting the financial soundness of banks and the banking system as a whole.

In the fulfilment of its mission the Bank performs virtually the full range of functions and duties that are customarily carried out by central banks. The other main functions of the Bank are:
1) the issuing of banknotes and coin
2) acting as banker to the government
3) acting as bank to private banks
4) providing facilities for the clearing and settlement of claims between banks
5) providing liquidity to banks and acting on a case by case basis as "lender of last resort"
6) engaging in open-market operations and
7) collecting, processing and interpreting economic statistics and other information.

3. The importance of price stability

The objective of achieving and maintaining price stability is based on the proposition that inflation is bad for economic growth, employment creation and the distribution of income. Is this indeed the case, or can more growth be attained by allowing an acceleration in inflation?

It is often argued that there is a trade-off between inflation and growth based on the Philips-curve analysis. In this analysis it was argued that at a low level of inflation real economic growth can be stimulated through an expansionary monetary policy even if this policy should lead to higher inflation. There may be some truth in this analysis over the short term, but such a policy will not achieve long-term sustainable high economic growth and employment creation. An artificial stimulation of demand inevitably results in higher inflation rather than production over the long term. If demand is allowed to grow more rapidly than the production capacity of the economy, this leads to inflation. It also results in rising deficits on the current account of the balance of payment. If these deficits are not readily financed by means of financial inflows, the exchange rate of the currency could come under pressure. A depreciating currency can bring forth further pressures on domestic prices. A little bit of inflation once started can easily gain momentum, which could require very restrictive measures to again attain balance between demand and supply. Substantial swings in interest rates to achieve such a balance make business planning difficult and could lead to lower average economic growth over the long term.

The maintenance of price stability over the long term implies low and more stable interest rates. With low inflation, output increases become more dependent on increases in investment and the quantity and quality of labour, and on the way that these production factors are employed. Economic growth becomes propelled by healthy permanent factors and is not dependent on an artificial stimulation of demand. Low inflation is therefore an important factor for sustainable high growth. In such a stable environment demand and output will grow on a steady and sustainable basis.

If price stability is not achieved, the well known disadvantages of inflation come into play. High inflation distorts the allocation of resources and favours investment in non-productive hedge assets rather than in capital formation. High inflation discourages saving and leads to more consumption. High inflation erodes the competitiveness of local manufacturers and other producers vis-

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