Inflation targeting in South Africa

Preface
The interest for emerging economies and, in particular , for South Africa, has been the initial cue for  
carrying on a research which would have been centred on macroeconomic issues for South Africa, 
as the title of this dissertation was intended to be in the proposal. 
The proposal of this dissertation differs a lot from which have been its effective developments: I 
chose to restrict the main argument of this dissertation to inflation targeting in South Africa and its 
results, as the adoption of this policy, with the commitment to contain inflation within the 
established target range, is one of the main tools to take into consideration when establishing future 
growth possibilities. 
I would like to thank Prof. Barry Harrison for his continuous support, encouragement and patience 
in assisting me during the stages of dissertation writing.
                                                                        Stefania Angela Viviana Serrao
                                                                        Caserta, 16 April 2008
1.Introduction
Chapter 1 presents an overview of the research about inflation targeting and an
exposition of the subject,. First, the background of inflation targeting is discussed. This
highlights the reasons for which inflation targeting has been chosen as a monetary policy 
in South Africa, then proceeds with the aim, defining the central question of the research.
Finally, the project structure is clarified to guide the reader through the rest of this report.
1.1Background
Inflation targeting was adopted by New Zealand in 1990 as monetary policy and it is now used by 
around 20 countries in the world. In countries adopting inflation targeting, many indicators of 
macroeconomics have improved: inflation rate and inflationary expectations declined, output 
growth has not worsened (Bernanke, 2003).
In addition, the adoption of inflation targeting has improved communication between the central 
bank and the public  through obliging the central bank to establishing clear goals for monetary 
policy, define responsibilities, establish measures for accountability and trasparency(Sterne, 2001).
Nonetheless, the effectiveness of inflation targeting as a monetary policy has been posed under 
exam by several authors, also comparing it with other policies, as price level targeting, deemed to 
obtained better price stability (Svennsson, 1996 and Vestin, 2000).
The outcomes of these investigations have been varied, some claiming  that inflation targeting did 
not produce any appreciable improvements of macroeconomic performance of countries adopting it 
(Ball and Sheridan, 2002), while others claim that it did, producing favourable changes in the level 
of average inflation, output and interest rates variability (Neumann and V on Hagen, 2002).
The conclusion drawn from different opinions about inflation targeting id that it represents 
convergence towards “best practice” in monetary policy (Mishkin, 2000), at leat because it forces 
monetary authorities to an explicit commitment towars the achievement of a certain price level.
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Exploring the different features of an inflation targeting framework, what the main opinions
are about the usefulness of inflation targeting as monetary policy framework, will be the main 
topics covered in parts II and III.
South Africa adopted inflation targeting in February 2000: having reduced from a lecìvel of about 
15% , due to the implementation of uncoordinated expansionary policies, its level of inflation has 
been successively contained within the target range of 3%-6%, with occasional breaches of this 
band due to exogeneous shocks, as rising oil  prices and political turmoils in neighbouring  
countries (Zimbabwe, as an example), affecting inflation: how monetary policy reacted and to what 
extent and how inflation targeting has effectively contributed to improve macroeconomic 
performance of South Africa will be the topics covered in Part IV .
1.2 Aim
The focus of the dissertation is to shed light on major current problems in inflation targeting, results 
achieved in implementing this policy amd how it has been implemented in South Africa, with focus 
on special characteristics of inflation targeting in South Africa and the role of inflation targeting will 
play in the future of South African economy.
1.3 Central questions
The central questions of this research are as follows:
 Which are the major  features and problems of inflation targeting today?
 How has it been implemented in South Africa?
 Which characteristics of inflation targeting as monetary policy have been particularly useful 
for the recent macroeconomic performance of the country?
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1.4 Objectives
The following objectives are pursued: 
 Exploring the  main components of inflation targeting framework (target level, target 
bandwidth, escape clauses, inflation measurement);
 Exploring the results obtained by countries adopting inflation targeting:
 Detemining the impact of inflation targeting in South Africa
 Evaluating which would the future usefulness of inflation targeting in South Africa be.
1.5 Scope
The following section discusses the scope of the dissertation, including the limitations and some of 
the main assumptions made.
1.5.1 Inflation targeting frameworks
As a relatively new framework for monetary policy , inflation targeting has been posed under exam, 
questioning the effectiveness of this policy for the control of price level.
Various frameworks have been adopted for inflation targeting, with the main differences applying to 
economic features of the countries in question: the adoption of a certain target level, the choice of 
whether or not to include escape clauses within the inflation targeting framework and institutional 
instruments employed for its implementation.
1.5.2 Geography
Geographically, the research overviews inflation targeting  as (broadly) adopted in the world and 
then focuses on South Africa.
1.5.3. Literature
A wide range of literature is present on the main problems of inflation targeting and its adoption in 
South Africa. Thus, the approach followed implies:
1- reviewing how an inflation targeting framework can be modelled.
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2-giving accountof how inflation targeting results can be monitored and which conclusions can be 
drawn from different outcomes obtained.
3- reviewing the inflation targeting framework adopted in South Africa.
4- measuring the impact of inflation targeting in South Africa by looking at the change, over time, 
of the variables considered in the implementation of inflation targeting over the world.
5- on the basis of future proect of South African  government for the development of the country, 
assessing the role inflation targeting will play for South African growth.
1.5.4 Project structure
The parts are organized as follows:
Part I-defines the subject and the history of inflation targeting, giving accounts of which methods 
have been used to study its adoption  and impact, especially for South Africa, and giving a review of 
the literature.
Part II- examines the main features of inflation targeting frameworks
Part III- gives an overview of inflation targeting results
Part IV- examines the adoption of inflation targeting in South Africa
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2. Literature review
For what concerns the main features of an inflation targeting framework, literature draws from the 
works of Heenan, Roger and Peter (2006), offering an overview of the main features in designing a 
monetary policy framework, Coletti, Wilkins and Selody (2006), for what concerns  the target 
horizon, G.A. Kahn (2007), for what concerns communication and transparency of monetary policy, 
Roberts (2005), about underlying inflation measurement, and referral to the work of Barro (1995) 
and Sarel (1996) for the  relationship between inflation and growth. The work of Tuladhar (2005) 
sums up all the major features of inflation targeting framework used till now.
The issues preceding and following the design of an inflation targeting framework draw  results 
mainly from the works of Svennsson (1996) and Vestin (2000), for what concerns price level 
targeting as a policy often proposed as an alternative to inflation targeting, Ball and Sheridan  
(2003) and Neumann and V on Hagen (2002) for results obtained in the implementation of inflation 
targeting.
Comments on both the first and second parts are drawn from Mishkin's work (2000).
Concerning results obtained in South Africa by inflation targeting policy, the publications released 
by South African Reserve Bank (SARB), including Monetary Policy Reviews, have been  essential 
in order to obtain information on inflationary trends and monetary policy responses in the years 
2000- 2007.
Different contributions can be mentioned regarding the measurement of results achieved by 
inflation targeting in South Africa:
 concerning transparency of the central institutions: the work of Aron and Muellbauer (2005) 
apply the method to South Africa for institutions' transparency measurement employed by 
Ejiffinger and Geraats (2002).
 regarding inflationary expectations, the work of Kershoff and Smit (2002)  and the 
observation of variations in inflationary expectations through Monetary Policy Reviews. In 
addition, the work of Rigobon (2007) conveys a sort of “certification” for credibility 
achieved by the SARB through observing how the pass-through of exogeneous shocks to 
prices has been reduced over time;
 concerning output and interest rates variability, Smit and Du Plessis (2002) shed light on the 
importance of counterciclicality of inflation targeting in order to achieve less variability in 
output and interest  rates.
Occasional papers written for the South  African Reserve Bank, as those of Der Merwe (1996 and 
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2004) and public speeches, and those pronounced from the Governor of the Reserve Bank, TT. 
Mboweni, offer information about the history and evolution of inflation targeting in South Africa.
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