How credible is the cut?

For those prepared to listen, it was a mini-lecture on monetary policy. And more entertaining than lectures on monetary policy tend to be.

The occasion was the press conference the Reserve Bank governor gives to explain the reasons for decisions of the committee that decides on interest rate policy.

Tito Mboweni was explaining on Thursday, December 12 why the committee had decided on a half a percentage point interest rate cut in the Reserve Bank’s influential interest rate, the repo rate, to 11.5%.

An off-the-cuff statement by the governor in response to a question hit the news the same night (Thursday, December 11) as evidence that the man some South Africans apparently like to blame for their economic woes has taken the pleas of the public to heart and relented on interest rates.

What he said was:

“But let’s be fair to everybody; there are lots of folks out there who are under stress and you know one cannot conduct monetary policy as if you are an island unaffected by what happens on the mainland. And it’s very clear that the mainland might be experiencing lots of problems and one has to take that into account.”

However, he went on to say immediately:

“At the end of the day, though, the focus of the central bank must be on what the inflation outlook is going forward. We must never lose our focus on that. If we do, I think we are in serious trouble and we might cause a lot of confusion amongst ourselves and the rest of the population. Our view, therefore, is that the decision we have taken is not contrary to the achievement of our stated mandate.”

The Press Conference underlined the difficult high-wire act the Bank faces in deciding how to achieve its goal of price stability without excessive force. After all, the Reserve Bank could well raise interest rates a few percentage points at a time and kill off inflation once and for all, and the economy with it.

In the present worldwide financial turmoil and looming global recession it’s as though someone is shaking the rope while the bank tries to reach its main goal. If it ignores recessionary forces it could have high interest rates at exactly the wrong time. If it decides on vigorous stimulus it faces a credibility problem which fuels inflationary expectations.

Most will welcome as sensible even a modest interest rate cut at this stage but the Reserve Bank can never please everyone and Dawie Roodt, chief economist of the Efficient Group, was on Radio 702 the same evening claiming the decision to cut rates at all had damaged the Reserve Bank’s credibility.

For Roodt and others, more important than the absolute rate is the real rate, the difference between the inflation rate and an interest rate.

The real repo rate is now negative with inflation as measured by the consumer price index excluding mortgage bonds (CPIX) for October at 12.4%.

The picture might look better when Statistics South Africa releases its official inflation figures on Wednesday (December 17), but while Roodt did not actually address all the factors the MPC advanced for cutting rates (see www.resbank.co.za ), he is right to remember that interest rates are not that “high”.

Since some saving accounts earn less than the repo rate, they are already negative, which is effectively paying the bank twice to keep your money safe, once in bank charges and again in lost interest.

However, raising rates now is clearly out of the question: serious threats to the economy loom, though there is no reason to break out the lifeboats yet.

“Certain subsectors are in recession, but the whole economy is not in recession and is unlikely — from what we know at the moment — to go into recession,” Mboweni noted.

As if to answer Roodt’s criticism in advance, Mboweni mentioned that central banks all over the world faced a credibility risk now, as they battled with recession.

“Are we credible in what we are saying as we are reducing interest rates or providing more monetary accommodation? Are our explanations credible? And so we had to discuss in the detail of it that our explanations have to be credible. We have to be convinced about our decisions such that if you woke me up at 4am and asked me the question, ‘Why did you take that monetary policy stance?, I should with conviction be able to explain that to you. And I’m quite certain that we made the correct call in this instance.”

Mostly, the governor was at pains to stress two things at least: the Reserve Bank is independent of government, and its goal is price stability.

He repeated what he said at a previous MPC meeting, that the control of inflation cannot rest on the shoulders of the central bank alone.

“Most central bankers would understand that there is a limit to what monetary policy can do. Monetary policy can’t sort out the traffic lights, it can’t sort out the car manufacturing industry, it can’t sort out the electricity distribution system and it can’t sort out the anti-trust or competition issues in the economy.

“There’s a limit to what monetary policy can do and therefore there are other responsibilities that must be undertaken by other components of our society in order for us to move ahead.

‘Structural change, structural transformation is very important, for any economy, for that economy to grow and prosper. We know our limitations. We are in the business of controlling inflation, but we can’t do that on our own.”

Otherwise, the governor was in fine form, brandishing a small, ornamental knobkerrie, jokingly warning the journalists present that they risked being “clobbered if they asked difficult questions”.

He has a reputation for being impatient with reporters who ask what he regards as foolish questions because they don’t do their homework, or because they are off-topic.

At this press conference he was quite indulgent, taking time to answer questions that were really about monetary policy rather than the specific MPC meeting.

Perhaps this had something to do with his being a bearer of good rather than bad tidings, relatively speaking.

He was also at pains to underline how the decisions are not his alone.

Describing himself merely as the chairman of the committee, Mboweni explained in answer to a question about how low he thought interest rates would go, that he could not say. He approached each MPC meeting with an open mind about raising or cutting rates.

“The governors of the central banks are among the last dictators, but their power has been curtailed by committee,” he noted.