Reducing exchange rate volatility and supporting competitiveness

In this paper we analyze the relationships between exchange rates, inflation and competitiveness.  We show that over, the 1994-2006 sample period, real exchange rate depreciations did not improve the trade balance and therefore, had no positive effect on growth. One reason for this is that SA exports are priced to market (PTM) instead of producer currency pricing (PCP).  We also comment on the policy advice of the International Panel of Experts on Growth (The ‘Harvard Team’) on South Africa’s Accelerated and Shared Growth Initiative (AsgiSA) with respect to the present architecture of SA’s inflation targeting regime. Rodrik (2006) argues that since the health and vitality of the formal manufacturing sector has to be at the core of any strategy of shared growth, the South African Reserve Bank (SARB) should switch to a modified inflation targeting framework which allows considerations of competitiveness to affect its decision-making. We argue against this. Instead we show that if the monetary authorities would be interested in targeting competitiveness via the real exchange rate, a good way to do this is by narrowing the present inflation targeting band from the present 3-6 percent, to say 1-3 percent.