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‘Rigid' application of inflation targeting a ‘costly mistake', Stiglitz avers

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‘Rigid' application of inflation targeting a ‘costly mistake', Stiglitz avers

Acting as if low consumer-price inflation was necessary and almost sufficient for economic stability was a mistake, Prof Joseph Stiglitz said during a visit to South Africa. Camerawork: Nicholas Boyd; Editing: Darlene Creamer.

9th July 2009

By: Terence Creamer
Creamer Media Editor

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Nobel Memorial Prize winning economist Prof Joseph Stiglitz reiterated his stance that the "rigid" application of inflation targeting by central bankers had contributed to the onset of the current economic crisis and that containing inflation needed to be balanced with other concerns, such as sustaining growth and maintaining financial stability.

He added that it had been a "costly mistake" for governments to have pursued the policy excessively, but he stressed that he could not comment directly on the application of the policy in South Africa.

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Speaking ahead of a lecture, which he delivered in the Great Hall at the University of Witwatersrand on Wednesday, Stiglitz argued that many central banks had made the "mistake" of "acting as if low consumer price inflation was necessary and almost sufficient for economic stability".

"I don't think anybody believes that anymore," he quipped, adding that it was a product of the poor application of economic theory.

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The models employed by central bankers highlighted the distortions caused by relative price changes associated with moderate inflation.

But, Stiglitz, who was in South Africa for a meeting of the so-called Africa task force of the Initiative for Policy Dialogue, which would take place in Pretoria on Thursday and Friday, argued that the losses in economic efficiency caused by the meltdown of the financial system were larger by an order of magnitude.

"So, they were focusing on something that was really a second, or third order of magnitude, when they should have been focusing on something that was really important," he averred.

Inflation could become a serious problem if left uncontrolled. But, the authorities had to be certain that the application of interest rates could actually affect prices, particularly in developing economies where much of the inflation was caused either by external or imported factors, or administered price increases.

It was, therefore, at times, "absurd" to place the full burden of containing such prices on interest rates. "In some cases, bringing inflation down through the raising of interest rates was akin to the "cure being worse than the disease", as wage inflation was brought under control at the expense of job losses.

The Columbia University professor's censure comes at a time when some economists, supported by South Africa's largest labour federation, the Congress of South African Trade Unions, were intensifying calls for the South African Reserve Bank (SARB) to be released from its single mandate of maintaining inflation within a target band of between 3% and 6%.

These calls were amplified recently, after governor Tito Mboweni put a halt to what had been a rapid loosening in monetary policy when he failed to lower rates after the June meeting of the Monetary Policy Committee (MPC). The repurchase rate was unexpectedly kept at 7,5%, with inflation slowing less than expected to 8% in May.

Prior to the latest MPC decision, the bank had cut its key rate by a material 450 basis points since December as its attention shifted to economic growth as South Africa slumped into its first recession in 17 years.

However, many inflation-wary economists have argued that the SARB had not been overly rigid in its application of inflation targeting, particularly as the current crises evolved. They have noted, for instance, that the bank had continued cutting rates despite the fact that inflation had remained stubbornly out of range and above expectations.

Further, inflation-targeting advocates have stressed that the policy had been pursued locally in the context of continued financial stability, supported by sound financial market regulation, the absence of which was the true cause of the meltdown.

Finance Minister Pravin Gordhan said last week that South Africa would keep its policy of targeting inflation, which had helped to stabilise prices and encouraged economic growth.

Stiglitz agreed that poor regulation had been at the main cause of the collapse in the US banking system, which led to the global financial crisis.

He added that most governments had already moved to more flexible inflation targeting systems. "It has become just one of the list of things that monetary policy has to look at. And, that's the way I think it ought to be."

 

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