Proposed lockdown 'developmental mandate' for the Reserve Bank is unconstitutional

31 July 2020
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The SA Reserve Bank is afforded great independence in the Constitution for a reason.

Section 224 states that its primary objective is to protect the value of the currency in the interest of balanced and sustainable economic growth.

This constitutional mandate is also given effect to in section 3 of the SA Reserve Bank Act, which echoes section 224 almost verbatim.

The wording of the central bank’s mandate is important. It enshrines the notion that protecting the value of a nation’s currency is important, if not crucial, for achieving balanced and sustainable growth.

Calls are emanating from the vocal fringes to have the Reserve Bank undertake a "developmental" role considering the economic hardships imposed by the lockdown.

But the extent to which the Bank is asked to intervene in the real economy would not only require an overhaul of its internal policies, nor merely an amendment of the Act.

The Constitution itself would have to be amended if the Reserve Bank is to shuffle its priorities and shift the protection of the value of the rand down a notch in favour of unsustainable monetary, and thus eventual, price inflation.

Generally speaking, there are two ways to measure the value of a currency: what it can buy in terms of foreign currencies (exchange rates), and what it can buy in the domestic economy (inflation/deflation). So far, domestic consumers and producers have been shielded from the latter by the Bank's sound monetary policy.

The Reserve Bank utilises the interest rate mechanism (the repo rate) as its operational variable in order to implement its monetary policy, which focuses on inflation-rate targeting.

This mechanism affects the real economy through four main channels: short-term interest rates in money markets; long-term interest rates in debt markets; asset prices in the bond, equity, and fixed property markets; and exchange rates in the foreign exchange market.

In short, if the Reserve Bank undertakes extensive quantitative easing of measures, while it might provide a temporary boost to the economy, the overall effect of that would be the value of the currency eventually falling to unsustainable levels in terms of both its value on the foreign exchange market and its purchasing power in the domestic market.

This would directly undermine the Reserve Bank's constitutional mandate.

These effects will not be immediately noticeable, as monetary policy is notorious for its time lags.

We have probably not even experienced the full effects of the lowered repo rate yet. Ill-considered monetary policy today will lead to detrimental outcomes down the road, which will lead to the authorities forcing citizens to bear the costs through reductions in purchasing power as well as higher taxes.

Responsible and prudent monetary policy effected by the Reserve Bank, not a lack in aggregate demand, has managed to induce a disinflationary trend since 2016/17, and managed to keep the annual inflation rate within the target band of 3% to 6% for the past decade, apart from 2014 and 2016.

Keeping inflation in check is crucial to upholding the constitutional mandate of the Reserve Bank. The threat of runaway inflation in the age of fiat currencies is always lingering and keeping the inflation rate within the target band is beneficial to everyone in the economy.

Apart from the unconstitutional nature thereof, it is thus also a terrible economic idea to have the monetary authority fund the expansionary fiscal policies of government more than what it is already doing.

It would require even more extensive monetisation of government debt which would risk reversing the roughly five-year long disinflationary trend, as well as scare away investors from what is currently a liquid, attractive financial market.

The current temporary slump in the monthly inflation rate below the 3% floor of the target band should not be mistaken for an opportunity to rapidly pump the economy full of artificial liquidity. The slump is due to the Covid-19 coronavirus lockdown.

Once the economy gets going again, a transition which could be quite rapid, the Reserve Bank will be unnecessarily burdened with the task of trying to extract a lot of money out of the economy very quickly through a time-lagged mechanism.

In general, however, calls for a developmental mandate are not new and there is most likely a political agenda driving them.

Government is facing the reality of a debt crisis of its own creation. The financing costs of debt is spiralling out of control and the ever-increasing deficit necessitates more and more borrowing.

Government would, temporarily, benefit extensively from the Reserve Bank pumping massive amounts of liquidity into the market, but at a massive long-term cost.

Inflation benefits current borrowers by effectively decreasing the real value of their debt when the inflation rate trumps the interest rate attached to the debt. A spike in inflation down the line would make it easier for government to pay off rand-denominated debt.

Prospective lenders to government would also want higher yields to compensate for the inflationary risks, but this would not be possible considering that yields on government bonds would be pushed down if extensive debt monetisation by the Reserve Bank occurs.

All of this would eventually catch up with government, as real yields on government bonds would be pushed down, making them unattractive to investors and thus severely curtailing government's ability to borrow on the open market.

The risk is thus that the Reserve Bank would not simply be a lender of last resort but might well become the main lender if extremely low or even negative real yields on government bonds materialise due to debt monetisation coupled with inflation.

Calling on the Reserve Bank to undertake policies that stand directly in contrast to its constitutional mandate is ill-considered and highly unethical, especially considering the contemporary pressures that are already exerted upon the constitutional integrity of democratic South Africa.

It is also not the Reserve Bank’s fault that the fiscal authorities engaged in extensive, detrimental deficit spending at times when growth was positive. It should not be expected to clean up the mess created by the fiscus.

This article was first published on City Press on 23 July 2020

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