Speaking on the third day of the Department of Political and International Studies Annual Teach-in, the Reserve Bank’s Greg Farrell argued that rather than coming as a complete surprise as is sometimes argued, prior to the current financial crisis there were those who warned that the world’s economies were on a dangerous path. Although the timing and form that the crisis would take were not known in advance, the risks of the strategies that were being employed were known.

Presenting the South African perspective on the crisis he focused on three main topics:

• The consensus view on the role of monetary policy in stabilising the real economy
• The response of central banks
• The lessons learned.

Farrell pointed out that while the central bank policy of inflation targeting is sometimes criticised there is some misunderstanding of the policy. The consensus in economic circles is in favour of flexible inflation targeting and this is indeed the policy of the South African Reserve Bank rather than the straw person of rigid and strict inflation targeting that is sometimes set up for criticism. Strict inflation targeting would imply meeting any deviation from the inflation target with an aggressive monetary policy response. Most central banks, including ours, are flexible targeters.

He pointed out also that central banks are involved with monetary policy and we need to be clearer about the limits on what monetary policy can and cannot do. Monetary policy does not have a sustained impact on real economic activity. Rather, potential economic output is determined by factors such as investment, labour, infrastructure, innovation and so on. So there are limits on the impact of what central banks can do in the economy.

Focusing on impairment of the transmission mechanism Farrell argued that in response to the crisis central banks lowered real interest rates. In the advanced economies this brought them close to zero interest rates raising the issue of the zero lower bound constraint. In practice nominal interest rates cannot be lowered further once they reach zero so once they do reach this point there is a natural constraint on the further role of the central bank in the economic crisis.

Farrell noted the lag in the impact of the crisis on the South African economy. Our banking system was left relatively unscathed partly because we had been running a current account deficit and so were in international markets to borrow rather than for exotic investment purposes. This cushioned us when these investments went bad. Once the crisis hit the Reserve Bank began to reduce interest rates (5 percentage points between December 2008 and August 2009).

This was done despite inflation being outside of the inflation target range. In other words the bank was true to the policy of flexible inflation targeting, proving that its approach to inflation targeting was not rigid and was not applied regardless of circumstances. A further plus factor was the fact that there was infrastructure spending going on in preparation for the World Cup, thus cushioning the blow of the crisis on our economy.