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Monday, 7 December 2009

Inflation and Economic Growth

“The South African Reserve Bank (the SARB) 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. The Bank has a floating exchange rate policy and there are no exchange rate targets.

Financial stability is not an end in itself, but, like price stability, is generally regarded as an important precondition for sustainable economic growth and employment creation.”


SARB

The average annual inflation rate in SA has been 6% over the last 10 years while Tito Mboweni was the Governor of the SARB. This is half the 12% average annual inflation rate during the 18 years before Mboweni took over the helm at SA´s central bank.

SA is thus committed to low inflation. This is the correct policy.

“Real economic gain can be achieved by reducing the trend growth of money.”

Money, Inflation and Economic Growth. Keith Carlson, Federal Reserve Bank of St. Luis. 1980

“Monetary policymakers have assumed that faster sustainable growth can only occur in a climate where the inflation monster is tamed.

A reduction in inflation of even a single percentage point leads to an increase in per capita income of 0.5 percent to 2 percent.

As the authors point out, their analysis leaves little room for interpretation. Inflation is not neutral, and in no case does it favor rapid economic growth. Higher inflation never leads to higher levels of income in the medium and long run, which is the time period they analyze. This negative correlation persists even when other factors are added to the analysis, including the investment rate, population growth, schooling rates, and the constant advances in technology. Even when the authors factor in the effects of supply shocks characteristic of a part of the analyzed period, there is still a significant negative correlation between inflation and growth.

Inflation not only reduces the level of business investment, but also the efficiency with which productive factors are put to use. The benefits of lowering inflation are great, according to the authors, but also dependent on the rate of inflation. The lower the inflation rate, the greater are the productive effects of a reduction. For example, reducing inflation by one percentage point when the rate is 20 percent may increase growth by 0.5 percent. But, at a 5 percent inflation rate, output increases may be 1 percent or higher. It is therefore more costly for a low inflation country to concede an additional point of inflation than it is for a country with a higher starting rate. Given their detailed analysis, the authors conclude that "efforts to keep inflation under control will sooner or later pay off in terms of better long-run performance and higher per capita income.”


Does Inflation Harm Economic Growth? Evidence for the OECD: Javier Andres, Ignacio Hernando, The US National Bureau of Economic Research, 1997

“The tests revealed that a weak negative correlation exists between inflation and growth, while the change in output gap bears significant bearing. The causality between the two variables ran one-way from GDP growth to inflation.

Correlation coefficients showed only a weak negative link, while causality was shown to run from economic growth to inflation. With the majority of Fiji’s inflation being imported, the influence of domestic factors (being unit labour costs and to a lesser extent the output gap) is limited. The findings of other empirical studies, however, provide some guidance for Fiji policymakers on the importance of maintaining low inflation, in order to foster higher economic growth. For its part, the Reserve Bank of Fiji will need to maintain monetary policy consistent with low inflation and inflation expectations.”

Relationship between Inflation and Economic Growth: Gokal and Hanif, Reserve Bank of Fiji, 2004

“ There are also significant feedbacks between inflation and economic growth. These results have important policy implications. Moderate inflation is helpful to growth, but faster economic growth feeds back into inflation.

Attempts to achieve faster economic growth may overheat the economy to the extent that the inflation rate becomes unstable. Thus, these economies are on a knife-edge. The challenge for them is to find a growth rate which is consistent with a stable inflation rate. They need inflation for growth, but too fast a growth rate may accelerate the inflation rate and take them downhill as found by Bruno and Easterly (1998).”

INFLATION AND ECONOMIC GROWTH: EVIDENCE FROM FOUR SOUTH ASIAN COUNTRIES, Asia-Pacific Development Journal Vol. 8, No. 1, June 2001, Girijasankar Mallik and Anis Chowdhury

Kindest regards,

Nicolaas Smith