SARB more transparency please: OECD

19 July 2010 - 16:40 By Sapa
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While SA's inflation targeting framework had proven to be flexible, its credibility could be strengthened, the Organisation for Co-Operation and Development (OECD) says.

A high degree of transparency and convincing monetary policy reports were considered indispensable for establishing and maintaining credibility, the international organisation, which helps governments solve economic and social problems, said in its first economic survey of the country.

"Empirical evidence suggests that higher transparency is an integral part of monetary frameworks that are associated with better anchored inflation expectations and more stable inflation outcomes."

The South African Reserve Bank's communications strategies were in line with those adopted by the major OECD central banks. They included announcement and explanation of policy changes in monetary policy committee statements and publication of economic forecasts.

However, the OECD suggested the SARB give a little more guidance in its view of interest rates, not only its view of inflation.

"The SARB provides less guidance regarding future policy inclinations, assuming a constant-rate interest rate path... in its inflation forecast."

This assumption could be unrealistic and lead to biased forecasts.

Relaxing it would allow the central bank to decide on and communicate to the public the optimal inflation path, instead of limiting it with a single possible outlook for inflation, once a policy rate decision had been made.

The practice of deciding on and publishing the optimal policy rate path was pioneered by the Reserve Bank of New Zealand and adopted by several other central banks, including those of Norway and Sweden.

The SARB's flexible targeting of inflation was reflected in its response to rising inflation in 2007-2008.

"The rise in policy rates in the period between May 2007 and April 2008, from nine to 12 percent was less steep than warranted by inflation developments alone and as a result, inflation remained outside the target band for 30 consecutive months."

This was a dilemma for the SARB.

"Rising headline inflation affected inflation expectations that ratcheted upwards despite the tightening cycle and this suggests that the credibility of the central bank suffered."

At the same time, the SARB was criticised for an inappropriate tightening in response to inflationary developments outside its control and, more generally, for not paying attention to growth and employment objectives.

Enhancing the credibility of the inflation target was vital.

"Not only is the anchoring of expectations the main precondition for the stability of inflation outcomes, but greater credibility would also provide the SARB with more freedom to implement a flexible approach to inflation targeting in the future."

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