A focus on inflation containment has for decades been one of the pinnacles of central bank policy around the world. It has certainly been an article of faith with the US Federal Reserve, the world’s most influential central bank. For years its Federal Open Market Committee (FOMC) fine-tuned monetary policy in the world’s largest economy to the beat of a 2% inflation rate. 

That almost single-minded focus vanished last week. The Fed is now primed to support a strong labour market.

“The economy is always evolving, and the FOMC’s strategy for achieving its goals must adapt to meet the new challenges that arise,” Federal ReserveChair Jerome H. Powell said in a statement

“Our revised statement reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities, and that a robust job market can be sustained without causing an unwelcome increase in inflation.”

The statement went on to say that 2% inflation is no longer the rigid goal but an average, which will allow more flexibility. In the past, the FOMC would have hiked rates if inflation looked set to accelerate beyond 2%. Now it can wait until that level is breached in the interest of sustaining employment. 

The underlying premise here is that higher interest rates raise the cost of borrowing for businesses and consumers and so can have a detrimental impact on employment. Very low rates of unemployment have historically also been linked to higher inflation as it allows the workforce to be more demanding when it comes to wages and salaries, which in turn can fuel price pressures. 

So this marks a significant policy shift against the backdrop of the economic woes triggered by the Covid-19 pandemic, though it seems the Fed was looking into the issue even before the outbreak struck. 

Writing in Axios, the respected financial commentator Felix Salmon said “America has a new central bank … This news represents a radical change in how the Fed thinks about its job. It will provide powerful ammunition should European Central Bank (ECB) ECB president Christine Lagarde want to start trying to make similar changes.” 

Of course, if the ECB were to follow a similar path, it could open the flood gates. It would certainly provide cover for the South African Reserve Bank (SARB) to at least consider changes to its policy approach in consultation with government.  

The SARB’s mandate requires it “to achieve and maintain price stability in the interest of balanced and sustainable economic growth in South Africa. The achievement of price stability is quantified by the setting of an inflation target by government that serves as a yardstick against which price stability is measured.” Among other things inflation generally hits the poor the hardest as it quickly erodes low incomes and wages.  

The SARB’s inflation target is 3 to 6% and it has been comfortably inside there for some time, not least because of weak demand pressures in a moribund economy. In July, South Africa’s CPI sped up to 3.2% from 2.2% in June, but that is at the bottom of the range. And in the face of the economic misery wreaked by the pandemic, the SARB has made dramatic cuts of 300 basis points in the year to date – cuts it has been able to make while sticking broadly within its mandate. 

SARB Governor Lesetja Kganyago has repeatedly said the bank will not stray from its mandate. He has warned against the concept of “magic money” and firing up the printing presses and said this is not the time to “venture into policies or instruments that have proved a failure in economic history”.

Anyone who wants to print money should just look north to Zimbabwe to see how that has worked out. 

Still, there are elements in the ANC that would like to see changes to the SARB’s mandate and approach. With the Radical Economic Transformation faction, it can probably be dismissed as a populist ploy to detract from critical issues around shoddy governance and corruption. But a focus on employment clearly has resonance with the ANC’s labour allies.  

And now that the Fed has made such a move, expect conversations around the SARB’s mandate to heat up. DM/BM