Prices & inflation

extract from MMS Service 13-July-01

Will the business cycle help inflation targeting?

Summary :The business cycle upswing is still in progress, albeit with reduced momentum. This is not bad news for inflation targeting, but is not conducive to a significant decline in inflation. It will be important for the SARB to dampen inflationary expectations with a conservative policy stance.  
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Historical precedent in the 80's:
(a) Until the early 80's there was a positive relationship between the business cycle and inflation, with the business cycle leading by about 6 months. This came to an end in the mid 80's.
(b) From 1984 until the early 90's SA tended to experience a period of stagflation, with relatively high inflation and modest growth. The economy was isolated and producers, through sanctions and high tariffs were able to pass on cost increases, despite weak demand for their products. This resulted in an inverse relationship between the business cycle (growth) and inflation. This relationship started to break down in the early 90's, mainly due to the attemps by Dr Stals to reduce inflation through a high interest rate policy.

Historical precedent in the 90's:
(a) From about 1992 the positive relationship between the business cycle and inflation became re-established. (b) Since 1995 there has been a positive relationship between the business cycle and inflation, with very little lag between the two. The economy is much more open than in the 80's and exposed to all the forces that play a role in the international economy.

The outlook for the business cycle: From the analyses presented earlier this week it should be clear that although the economic upswing hesitated in the 1st qtr of the year and seemed quite weak in the 2nd qtr, the fundamentals were pointing to a continued upswing, albeit with less momentum.

The outlook for the business cycle & inflation: Given the positive relationship which had been re-established, it can be expected that continuation of the economic upswing will, ignoring all other influences, make a decline in inflation difficult. The fact that the business cycle upswing has lost some momentum will help though.

 

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e c o n o m e t r i x 13-Jul-01