The Inflation Target Should Be 0%

If they genuinely want to fulfill their constitutional duty, the SARB and its various committees should aim for an even lower inflation target, ideally around 0%.

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Inflation is the general rise in prices across the economy. However, this is just a consequence of the phenomenon, not its actual occurrence. Central banks around the world, including the South African Reserve Bank (SARB), are responsible for inflation. Those furthest removed from the central banking system feel its effects the most.

The media will sometimes mention or imply that inflation stems from businesses increasing their prices. Those opposed to the idea of free trade and enterprise even go so far as to say that inflation is the fault of greedy capitalists.

This view is partly true if you consider that businesses are the ones who raise their prices. Yet that is what French Liberal School thinker Frederic Bastiat would call the ‘seen’ only. In economics and in life in general, one must consider both the ‘seen’ and the ‘unseen.’

In this case, the unseen factor is the devaluation of the medium of exchange’s value (currency) resulting from a central bank’s monetary expansion. Central banks introduce new money into an economy without the necessary increase in productivity beforehand. This results in more money chasing fewer goods, causing the value of the medium of exchange itself to decline.

Chief among the ways central banks increase the money supply in circulation is through open market operations, which are integral to the modern banking system, such as purchasing government bonds from financial institutions and creating new reserves to pay for them out of thin air.

As an example, let us the SARB buys R1 Billion in government bonds from Banks A, B, C and D. Then to ‘pay’ for these bonds, the SARB creates R1 Billion in reserves for Banks A, B, C and D. Then due to fractional reserve banking, all these banks will now lend multiples of that amount in the economy, further inflating the money supply.

The effect is that there is now R1 Billion in the economy that was created out of thin air, without a corollary increase in the goods and services produced by the economy, amounting to said R1 Billion. With fractional reserve banking, the fraudulent practice of not holding the entirety of the reserves of a bank, the new money injected becomes even higher.

There are other ways in which central banks increase the monetary supply, such as acting as the lender of last resort, quantitative easing, balance sheet expansion, and the more commonly known lowering of interest rates.

Yet, for purposes of illustration, the bond buying and reserve creation should be enough. The point being that an increase in the supply of money in circulation, not the price increases it causes, is inflation.

Therefore, when prices rise, along with the hardships they cause especially for low-income households, the blame should be placed on central banks. Inflation is not an inevitable or naturally occurring phenomenon, like a natural disaster. It results from the intentional actions of monetary institutions, meaning its effects can be avoided by simply changing those actions.

The South African Constitution, Section 224, states that the primary object of the SARB is the protection of the value of the South African currency. The SARB doing something like what it did in 2020 with the purchase of government bonds in the secondary market is a direct contradiction of that mandate.

If the Reserve Bank is committed to following the prescriptions of section 224, the inflation target should be 0%, not the current 3%. Inflation is the devaluation of the currency’s purchasing power. By aiming for any inflation above 0%, the SARB is acting contrary to the Constitution.

Inflation, that is, the expansion of the money supply, is particularly damaging to those at the lower end of the income scale in an economy like South Africa’s. Beyond the price increases, which will obviously affect those with a relatively low income more harshly, it creates wealth redistribution that benefits those already with high incomes.

The Cantillon effect states that money created through credit expansion, sourced from central banks, does not enter the economy neutrally. It first goes to those institutions closest to the central banking system: Banks and financial institutions, large asset markets, and the government.

The result is that those institutions and the individuals associated with them get to use the new money before it has circulated enough in the economy for prices to adjust to the increase in supply. Meanwhile, the rest of society, which will receive the new money much later, will lose purchasing power after prices have risen in response to the increase in supply.

Research in South Africa has shown that the SARB’s bond-buying in 2020 increased the money supply and had inflationary effects. This monetary action created a skewed distribution of benefits between high-skilled workers (likely those employed by institutions closer to the central banking system), and low-skilled workers.

The monetary policy in 2020 saw real wages for high-skilled labourers remain stable or even increase, whilst real wages for low-skilled workers, who already earn relatively lower incomes, decreased.

If one considers the insights of the Cantillon effect, then such a phenomenon is understandable. Those with higher skills and higher incomes receive the new money first, most likely. By the time it reaches the low-skilled workers, prices have adjusted, and its purchasing power has decreased.

Inflationary practices of various kinds most severely affect those at the lower end of the income scale. Research has shown that a more conservative monetary policy, which seeks to keep inflation as low as possible, is beneficial to people on low incomes.

The lower the inflation, achieved by doing less of the things that cause inflation, the greater the benefit to the poor. While asset prices will not rise as much and debt servicing costs will be high in such an environment, these factors do not affect the poor as much as the prices of goods and services, which will stay more stable.

Inequality of income stemming from business or personal success is not a bad thing. Inequality stemming from the artificial wealth distribution caused by monetary expansion/inflation should be stopped.

South Africa is fortunate to have a constitutional provision that gives citizens the basis to demand a stricter monetary policy that will cause less inflation and better protect the value of the Rand than it currently does.

If they genuinely want to fulfill their constitutional duty, the SARB and its various committees should aim for an even lower inflation target, ideally around 0%. Until then, the theft and taxation of inflation on people experiencing poverty will persist unchecked, as they continue their march along the road to serfdom.

Zakhele Mthembu, BA Law LLB (Wits), is Policy Officer at the Free Market Foundation.