Pages

Wednesday, 17 February 2010

What price stability?

“The South African Reserve Bank is the central bank of the Republic of South Africa. It regards its primary goal in the South African economic system as the achievement and maintenance of price stability.

The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis.”
SARB.

Absolute price stability is a year-on-year increase in the Consumer Price Index of zero percent. A year-on-year increase in the CPI of above zero but below 2% is a high degree of price stability – it is not absolute price stability.

“The ECB´s Governing Council has announced a quantitative definition of price stability:

Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.

The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term.”
European Central Bank

http://www.ecb.int/mopo/strategy/pricestab/html/index.en.html

A below 2% year-on-year increase in the European Monetary Union’s harmonized CPI is the European Central Bank’s chosen definition of price stability. It is not the factual definition of absolute price stability. Theoretically, the SARB´s chosen definition of price stability is for “inflation to be within the target range of 3 to 6 per cent on a continuous basis”. In fact, the SARB´s chosen definition of price stability is for inflation to be 6% per annum on a continuous basis because when inflation targeting is implemented inflation generally trends to the upper limit.

SA accountants, on the other hand, simply assume that the Rand is perfectly stable in SA´s low inflationary economy, but, only for the purpose of valuing balance sheet constant real value non-monetary items which they account as Historical Cost items. In conformity with world practice they do not apply this assumption to the valuing of certain Income Statement constant items, namely salaries, wages, rentals, etc. They value other income statement items in nominal monetary units, i.e. at HC. SA accountants do not regard changes in the general purchasing power or real value of the Rand to be sufficiently important to measure financial capital maintenance in units of constant purchasing power as they have been authorized by the IASB in the Framework, Par 104 (a) in 1989.

They generally choose to implement financial capital maintenance in nominal monetary units, also authorized by the IASB in the Framework, Par 104 (a) in 1989. It is impossible to maintain the real value of capital stable by measuring financial capital maintenance in nominal monetary units per se during low inflation or deflation. Financial capital maintenance in nominal monetary units per se during inflation and deflation is a fallacy.

Kindest regards,

Nicolaas Smith

Copyright © 2010 Nicolaas J Smith