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Monday, 7 June 2010

Inflation normally rises to the upper level of the inflation targeting range

When a central bank governor says that the central bank’s primary task or objective is price stability what she or he means is that the central bank would be fulfilling its primary task, in an economy with low levels of inflation, when prices in general are slowly rising over time (that well known definition of inflation again). The flip side of the coin is that the real value of the national monetary unit is slowly being destroyed by inflation over time.

A central bank’s primary task being a high degree of price stability is the same as saying a central bank’s main responsibility is ensuring that inflation is maintained at a very low level. This low level was generally accepted in first world economies to be 2 percent per annum. The latest sub-prime crisis raised doubts about the 2% level being sufficient in the event of large shocks to the economy.

“In a world of small shocks, 2 percent inflation seemed to provide a sufficient cushion to make the zero lower bound unimportant.” P4


“Should policymakers therefore aim for a higher target inflation rate in normal times, in order to increase the room for monetary policy to react to such shocks? To be concrete, are the net costs of inflation much higher at, say, 4 percent than at 2 percent, the current target range?” P11

Rethinking Monetary Policy, IMF Staff Position Note, Olivier Blanchard, Giovanni Dell´Ariccia and Paulo Mauro, Feb, 2010.

We know that inflation is always and everywhere the destruction of real value in money and other monetary items over time. We also know that inflation has no effect on the real value of non-monetary items over time.

The maintenance of a high degree of price stability (still) means that the primary task of a central bank in a first world economy is to limit the destruction of real value in money and other monetary items by inflation to a maximum of 2 percent per annum within an economy or common monetary area. Continuous two per cent annual inflation destroys 2% of the real value of money and other monetary items per annum and 51% over 35 years.

Under the current Historical Cost paradigm it also means that accountants unknowingly destroy 2% of the real value of constant items never maintained, e.g. companies´ capital and profits never maintained with sufficient revaluable fixed assets, per annum and 51% over 35 years time with their very destructive stable measuring unit assumption. This unknowing and unnecessary destruction by accountants would be eliminated completely when accountants freely choose to measure financial capital maintenance in units of constant purchasing power during low inflation as they have been authorized in IFRS in the Framework, Par 104 (a) in 1989.
SARB

“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.

The SARB may state officially that it has an inflation targeting range of 3 to 6 per cent per annum. In practice that target is 6 per cent per annum because inflation normally rises to the upper level of the inflation targeting range. The SARB´s official task is thus to limit the destruction of the real value of the Rand currently to 6 per cent per annum.

What does that mean in practice?

Kindest regards

Nicolaas Smith
realvalueaccounting@yahoo.com

Copyright © 2010 Nicolaas J Smith