1. INFLATION & INFLATION TARGETING by Dr Azar Jammine Director & Chief Economist, Econometrix (Pty) Ltd Presented to Parliamentary Sub-Committee on Finance

24. CONTRIBUTORS TO INCREASED INFLATION 2002

32. INFLATION RATE FORECASTS 2001200220032004 CPI Inflation (%)5.79.47.85.2 CPIX Inflation (%)6.69.57.05.4 PPI Inflation (%)8.514.28.15.8

33. EMERGING MARKETS REAL MONEY MARKET INTEREST RATES (14/09/2002)

39. OPTIONS AVAILABLE ON INFLATION TARGETING n Abandon Inflation Targeting n Raise Target n Change Inflation Measure to Target (from CPIX to Underlying {i.e. excl. food, housing & vehicle running costs}?) n Invoke Escape Clause n Miss the Target

40. ABANDON INFLATION TARGETING Advantages n No longer bound to fight inflation vigorously, thereby harming short-term growth n Critics of inflation-targeting placated Disadvantages n Government and Reserve Bank lose credibility in fight against inflation n Risk of Rand coming under pressure with even worse inflationary consequences n Interest rates might have to be raised eventually to even higher levels n Return to boom/bust cycles

41. RAISING TARGET Advantages n Meeting targets no longer a pipedream, thereby enhancing credibility of process n Simultaneous retention of target maintains vision of determination to fight inflation Disadvantages n Perception of fairweather flexibility to meet the prevailing situation may detract from perception of commitment to targets n Small risk of decline in currency with concomitant inflation and interest rates consequences

42. CHANGE OF TARGET MEASURE FROM CPIX Advantages n Exclusion of food & fuel would exclude volatility caused by factors other than economic policies n Exclusion of food, fuel & housing would render CPIX target range of 3 to 6% achievable and credible Disadvantages n Relatively ineffective in combating inflation more generally because of too many exclusions n Perception that government acting to please itself in fairweather fashion

43. INVOKE ESCAPE CLAUSE Advantages n Perception of this being appropriate given magnitude of currency depreciation and commodity price increases Disadvantages n Perception of lack of commitment to fighting inflation when the going gets tough n Risk of Rand depreciation with concomitant inflation and interest rate consequences

44. DO NOTHING Advantages n Releases pressure to raise interest rates further because of total loss of credibility n If inflation does fall sharply, government will have got away without undue harm n South Africa would not be only country to miss target Disadvantages n Inflation targeting seen to be farcical, leading to loss of confidence in commitment to fight inflation n Risk of Rand depreciation with concomitant inflation and interest rate increased

45. RECOMMENDATION n Retain inflation targets but increase ranges by 1% n Change to targeting underlying inflation rather than CPIX n Keep real interest rates positive at all times