March 31, 2004

Sometimes it is more appropriate to ask "how can we learn from the past?" rather than "what can we learn from the past?".

At the centre of what we can learn from history are the self-imposed limitations that we place on our view of history.

Few would disagree that not too many well-informed political commentators would have placed much probability on the peaceful transition to a new democracy in South Africa a decade ago.

Limited perspective on the dynamics of reconciliation may have contributed to this belief.

Historical "time-series" type analyses of economic variables can be as limiting
 
Throughout economic history there were inflection points where time-series analyses were made redundant.

How often have we heard ourselves say, "That will never happen in South Africa. South Africa is different"?

The most recent example of this would relate to the dynamics of inflation.

If we explore the history of inflation in South Africa it is easy to conclude that our strong labour unions, the lack of competition in our economy and the psychologically entrenched high levels of inflation are structural impediments too great for us to have inflation levels similar to our major trading partners on a sustainable basis.

Once we change how we look at history these impediments do not seem as restrictive.

A good example of this is the Canadian experience in the early 1990s. Market belief was that for Canada to remain competitive, inflation and interest rate differentials with the US had to be wide. Inflation was running in excess of 5 percent, and in 1990 nominal short-term interest rate differentials with the US peaked at 4.5 percent.

The common belief was that to continue to attract capital, this had to persist. However, Canada adopted a monetary policy framework which today, in the context of a prudent fiscal policy framework, has developed into a road map for moving to sustainable low inflation.
 
 
In 1990 Canada adopted inflation targeting, a relatively unknown policy framework at that time. Following what is today recognised by the International Monetary Fund and World Bank as a winning formula for changing economies, the Canadians applied fiscal and monetary discipline.

By the second half of the 1990s inflation was structurally lower, nominal interest rate differentials with the US had closed altogether, foreign direct investment had increased and year-on-year growth in gross domestic product averaged above 4 percent.

Although one cannot attribute these advances solely to a successful inflation-targeting regime, what are the lessons?

This pattern has repeated itself around the globe, from the inflation-targeting pioneers in New Zealand to countries such as Poland, which needed a road map for entry to the EU, and to the east, where Korea recovered from an attack on its currency in the late 1990s to produce an economy of which price stability is a feature.

The following question therefore needs to be answered: now that South Africa has adopted this well-established road map to lower inflation, fiscal stability, structurally lower interest rates and stronger growth, will the pattern repeat itself or is South Africa just different?

Many would believe that recent inflation numbers signify the cyclical lows and that inflation has started its upward path to higher levels, to which South Africans are accustomed.

We do not believe this.

Significant effort by the fiscal and monetary authorities has been focused on moving South Africa to a structurally lower inflationary environment.

The monetary authorities have been, and will continue to be, unerring in their commitment to sustainable low inflation. We are about to discover that sometimes we can learn from history.

Bradley Anthony is head of Fixed Income at Quaystone