Fiscal and monetary policy in a commodity‐based economy¹

Abstract

A rough description of macroeconomic policy in South Africa would be that monetary policy concentrates on building nominal credibility through focusing on inflation, while the brunt of the responsibility for output stabilization rests on fiscal policy. This aricle discusses the convenience of such a policy mix. First, we estimate the business cycle impact of fiscal and monetary policy to find that so far fiscal policy has been mostly pro-cyclical, whereas monetary policy has been, over the last couple of years, mildly counter-cyclical. We argue that fiscal policy should be made significantly more counter-cyclical than it has been -a strategy that would deliver more macroeconomic stability and potentially higher growth. Furthermore, we believe the Central Bank has earned the credibility to operate macro policy with a more decisive output stabilization objective, and we discuss several reinterpretations of the inflation targeting regime that provide the flexibility to do so without risking the strong anti-inflationary credibility of the SARB. On exchange rate policy we recommend that the authorities take a pragmatic approach to floating, mostly allowing the currency to move freely, but intervening to avoid overvaluation. We explain why and discuss how this objective could be achieved.JEL classifications: F41 , F36, F32 .

Independence of Central Banks in Commodity Economies

“…Conventional targeting of inflation or different kinds of currency exchange rate fixation can't neutralize the aspect of the procyclicality of commodity economies, which is structurally specified by large shocks caused by terms of trade and reverses in capital flows. Frankel et al (2008) and Frankel (2010) offer shift the focus on targeting manufacturers' prices, but not CPI. Also, these investigations of monetary policy are not dedicated to the role of the status of the central bank.…”

Price Stability and Inflation Targeting in Commodity Economies: Macroeconomics versus a Political Economy?

“…However, IMF (2012), Heenan et al (2006) and Roger (2010) point out that inflation targeting is precisely the method that a number of commodity-rich economies try to use to decrease macroeconomic volatility. Frankel et al (2008) and Frankel (2010), in turn, find that inflation targeting in the resource-wealth case is not as counter-cyclical as expected. Maintaining price stability amid a positive commodity shock, they argue, requires a substantial strengthening of the exchange rate, just as a shock to commodity import prices requires comparable upward pressure on the exchange rate from higher interest rates.…”

“…Despite these positive aspects, criticism of inflation targeting (Frankel et al, 2008;Frankel, 2010) stems from the idea that stabilizing inflation and maintaining it within a target zone are actions opposite to offsetting a terms-of-trade shock. The important role of the exchange rate in shaping the trajectory of potential GDP is also seen as an impediment to inflation targeting, which is based on the principle of a floating exchange rate.…”

Building back fairer from the Covid-19 pandemic in South Africa: Some first step reforms in an era of fiscal constraints

“…Nowak and Ricci (2006) cover similar ground, but with a longer historical view that shows the difficulty of breaking the inflationary patterns developed in the 1980s and the beginning of the 1990s. After that the literature focuses on the performance of the inflation targeting regime (Du Plessis et al 2007;Frankel et al 2008), its effect on private sector expectations (Reid 2009;Kabundi et al 2015), its credibility (Kabundi and Mlachila 2018), and its transparency and communication (Reid and Du Plessis 2010). Following the global financial crisis (GFC), the independence of the SARB and its mandate as expressed in article 224 of the Constitution 1 (Republic of South Africa, 1996) and the policy framework of the SARB have come under scrutiny (Padayachee 2014), mainly as a response to continuing economic stagnation.…”