The South African Reserve Bank's mission is to protect the value of the rand by combating inflation. Inflation is a process of continuous increase in the prices of most goods and services in a country. This does not necessarily mean that all prices increase. There may be some exceptions, such as computer prices which have actually declined in recent years. Inflation can therefore be described as a persistent, general increase in prices.
How inflation is measured
Inflation is measured by defining a basket of goods and services used by a "typical" consumer and then keeping track of the cost of that basket. In the twelve months up to January 2007, the cost of that basket rose by 6 per cent. This increase of 6 per cent in the so-called consumer price index is referred to as the inflation rate.
Why inflation is bad
Inflation is regarded as a bad process because it leads to distortions and problems in an economy. Here is a short list of some of the key disadvantages of inflation:
Losses to savers: if you save your money by hoarding cash, inflation erodes the purchasing power of the amount saved. For instance, R100 put underneath a mattress ten years ago can now purchase only one third of the goods and services that it could have done in 1987. Even if you save in the form of savings deposits which pay interest, the interest may not be enough to compensate you in full for inflation. This also applies to pension planning, where people may, for example, save for a pension during their entire working life, just to find at the end of their career that their savings have been eroded by inflation.
Losses to people with fixed incomes: people with fixed incomes (such as the interest on a fixed deposit, or a fixed salary) find that the purchasing power of their income diminishes over time. The wealthy, by contrast, can usually partly protect themselves against inflation by investing in assets, such as shares or property, which increase in value during periods of inflation. Inflation therefore leads to an increase in the disparity between the wealth of the "haves" and the "have-nots".
Losses to taxpayers: if your salary increases in line with inflation, and no adjustments are made to income tax, you will shift into a higher tax bracket and end up paying a larger share of your salary to the tax office. This means that government gains control over an increasing proportion of society's resources without formally getting the approval of Parliament to raise taxes.
Reduced attention to productivity: higher productivity is an important sustainable way of improving the overall standard of living in a country. In the absence of inflation, wage negotiations are focused on proper compensation to employees in accordance with improvements in their productivity. With high inflation, salary or wage increases consist overwhelmingly of compensation for inflation, and productivity issues become less important and may be neglected.
Heightened tension and social disruption: a society plagued by high inflation devotes more energy to redistributive issues, in which case each person or group perpetually tries to gain or regain a better price, wage or position. This destroys the fabric of society in a wider sense than simply through its impact on the production of goods and services.
Quite a few people claim that inflation is not bad; they argue that higher inflation will stimulate economic growth. But the South African Reserve Banks believes that these claims are false.
It is quite easy and inexpensive to print more money, thereby boosting inflation; even the poorest countries could do that. If this were the way to achieve economic prosperity, no poor countries would remain on earth. If money is printed to stimulate the economy it may work for a short period of time, but people will soon realise what is going on and instead of producing more they would simply start to increase prices and wages much more rapidly. In the end, the country would face high inflation with all the destructive and distortive effects outlined above, and would be certainly left with a weaker economy.
The South African Reserve Bank, like central banks in most countries, is therefore strongly opposed to inflation, and uses its monetary policy to combat it. Such policy action is conducive for continued economic growth, prosperity and a fair distribution of income and wealth.
Low inflation and a stable financial environment are indeed prerequisites for the achievement of these objectives on a sustainable basis.
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