Monetary policy change of guard

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By Cees Bruggemans, Chief Economist FNB.

Every SARB Governor these past forty years, from De Jongh to De Kock to Stals to Mboweni, has implied major change in style and policy substance.

We should expect something similar from Governor Marcus who likewise will undoubtedly stamp her own imprint on the office.

Where is she likely to lead us? Though history cannot offer any exact parallels, for circumstances are always unique, one is allowed to wonder.

The changeover from Governors De Kock to Stals now already twenty years ago still comes vividly to mind, and may be useful to recall.

Governor De Kock ultimately proved too determined to use interest rates pro-actively, trying to overly influence demand in an economy that was seriously malfunctioning on the supply-side.

Policy was increasingly desperate to still wring some more performance from a system that could no longer deliver, using demand manipulation to do so. Real interest rates had been allowed to go massively negative at times, eventually having to compensate at the peak of the cycle by going punishingly high.

This also reinforced the inflationary bias, cyclically peaking at 21.6% in February 1986 following a particularly virulent Rand depreciation, after which a new tightening interest rate cycle commenced.

When Governor Stals entered office in September 1989, the betting was that rates had already been raised adequately under Governor De Kock, prime reaching 20% from a 12% cyclical low in late 1986. But this view reckoned without Governor Stals.

There were apparently two immediate needs. Firstly, to establish credibility, changing an established mindset about how interest rates would be used. And, secondly, to set a new course.

Inflation at the time was hardly firmly under control, and a message was needed that the tough new Governor meant business. To great surprise, interest rates were raised once more that September (prime reaching 21%) and only then was the peak of the cycle achieved.

Credibility is extremely important in a SARB Governor and one might as well establish from the beginning that decisive leadership will be a fact.

Technically, that first Stals tightening had the further aim of raising real interest rates to a more adequate level, where Stals was determined to anchor interest policy for the longer-term, forcing the economy and its inflationary mindset to adjust to this new reality.

No more pro-active gyrations of the main policy tool (at least during Stals’s first term), deteriorating the cyclical fluctuations in real economic activity and inflation in a worsening boom-bust condition. Instead, stability would be pursued with vigour as inflation was more forcefully contained.

Governor Marcus’s entry has something in common with Governor Stals’s in one respect. Domestic forces, like in the 1980s, have again lately proven roguish in their inflationary behaviour, with the public sector riding roughshod over any inflation targets and large labour unions and businesses defending, and where possible promoting, their interests.

This has kept inflation elevated over the past year even as the external commodity price surge abruptly reversed and the Rand strongly recovered lost ground, which should by now have allowed a lower CPI inflation rate than the ruling 6.1%.

Inflation expectations seem to have slipped, if not quite fatally, with BER surveys projecting 5.5% to 8.5% among financial market participants, labour union leaders and business, compared to an inflation target of 3%-6%. Thus a minor misalignment has arisen, something Governor Mboweni ultimately could not prevent.

First things first. Governor Marcus may well feel the need to establish the credibility of her authority early on, especially with financial markets (favourably), but also with large labour unions and business interests.

On this score, being too soft even on a weak economy in which the inflation mindset has slipped modestly might not be a good idea.

This would be a credible basis for not easing interest rates next week, or for that matter in December. More practically, it would grant more time for the economy to show its paces as it enters recovery even as inflation still heads lower.

But having established herself credibly in office, one would expect quite soon a more definite policy course setting for the first term.

Will economic softness, importantly contributed by a tighter domestic credit culture, a firming Rand forced upon us by global influences and a rather shaken mindset among businesses and households brought on by events of the past two years be left unaddressed?

It can be argued enough has been done by lowering interest rates by 500 points, with the budget deficit boosted to 7% of GDP and the global economy also recovering.

The economy will certainly recover cyclically from hereon, but are interest rates appropriately pegged, given both inflation and real sector behaviour?

Overseas one has seen new flexibility in which macro policymakers have chosen to respond to events. Though our policymakers have also responded vigorously this year, the question remains whether more could still be done to assist the economy without endangering longer term behaviour. That will be a call for the new Governor.

Source: Cees Bruggemans, FNB, November 17, 2009.

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