In short
How central bank inflation targets and credibility affect inflation expectations, market behavior, and economic activity, especially when price shocks (e.g., tariffs) occur.
Guests
No guests mentioned; host is Arunima Sinha, Global Economist at Morgan Stanley.
Key claims
Central banks can’t “announce and be believed” without a credible framework and institutional/political consensus. Credibility comes from repeatedly hitting the target, not from setting it. Look-through to one-off price spikes works only if expectations are anchored.
Notable examples
Fed’s “transitory” COVID inflation view; South Africa Reserve Bank (SARB) shifting from 3–6% to effectively targeting 3% and pulling inflation down; need for Ministry of Finance action; Brazil’s 1999–2024 target reductions amid fiscal/currency volatility.
Written by AI. May contain mistakes. Listen to the episode to check what was said.
Chapters
Tap a time to open that second in VOUnderstanding Inflation and Central Bank Credibility
0:21 to 1:06
Explore how inflation targets and expectations affect economic activity.
“The received wisdom is that a central bank should look through one-off increases in prices if, and it is an important if, inflation expectations are anchored low enough.”
South Africa's Inflation Target Experiment
1:06 to 1:48
Discuss the South African Reserve Bank's approach to inflation targeting.
“Far away from the U.S., the South Africa Reserve Bank, SARB, is providing a real-time experiment.”
Lessons from Brazil's Inflation Targeting
1:48 to 2:44
Examine how Brazil's inflation targeting experience can inform other countries.
“Key to the SARB's challenge, as the feds, the central bank cannot control all the drivers of inflation in the short run.”
The Importance of Institutional Strength
2:44 to 3:41
Understand why institutional frameworks and political consensus are crucial.
“The lessons apply to South Africa and also the Fed.”
The Challenges of Announcing Targets
3:41 to 4:27
Analyze the implications of simply announcing inflation targets versus achieving them.
“We take the experiences of South Africa and Brazil to be informative globally.”
Transcript
Automatic transcript. May contain errors.0:00Arunima Sinha:Welcome to Thoughts on the Market. I'm Arunima Sinha, Global Economist at Morgan Stanley. Today, I'm going to talk about how inflation targets of central banks matter for market participants and economic activity. It's Tuesday, August 12th at 10 a.m. in New York. Tariff-driven inflation is at the center of financial market debates right now. The received wisdom is that a central bank should look through one-off increases in prices if, and it is an important if, inflation expectations are anchored low enough. Inflation targets, inflation expectations, and central bank credibility have been debated for decades.
0:46Arunima Sinha:The Fed's much-criticized view that COVID inflation would be transitory was based on the assumption that anchored inflation expectations would pull inflation down. The Fed is more cautious now after four years of above-target inflation. Can a central bank simply announce an inflation target and get everyone to believe it? Far away from the U.S., the South Africa Reserve Bank, SARB, is providing a real-time experiment. The SARB's inflation target was originally a range of 3 to 6 percent, with an intention to shift to 2 to 4 percent over time. At its last meeting, the SARB announced that it was going to target the bottom end of the range, de facto shifting to a 3 percent target.
1:37Arunima Sinha:A decision by the Ministry of Finance in the coming months is likely necessary to formalize the outcome. But the SARB has succeeded in pulling inflation down. It has established credibility, but we suspect that more work is needed to anchor inflation expectations firmly at 3%. Key to the SARB's challenge, as the feds, the central bank cannot control all the drivers of inflation in the short run. For South Africa, fiscal targets and exchange rate movements are prime examples. The experience in Brazil offers insight for South Africa. The BCB adopted an inflation target in 1999 following the end of the currency peg that helped the transition away from hyperinflation.
2:26Arunima Sinha:The target was initially set at 8%, lowered to 4.5 % in 2005, and then lowered again to 3 % in 2024. Fiscal outcomes, market expectations, and currency volatility have been hard to contain. The lessons apply to South Africa and also the Fed. Successful inflation targeting relies on a clear framework, but also on institutional strength and political consensus. For South Africa, as inflation falls, ex-ante real interest rates will rise. That outcome will be necessary to restrain the economy enough to make sure that the path to 3 % is achieved. For an open EM economy, there likely needs to be consistency by both monetary and fiscal authorities with regard to short-term pressures, both internal and external.
3:27Arunima Sinha:While we ultimately expect the SARB to be able to anchor inflation expectations, the journey may not be a quick one. And that journey will likely depend on keeping real interest rates on the higher side to ensure the convergence. We take the experiences of South Africa and Brazil to be informative globally. Simply announcing an inflation target likely does not solve the problem. The Fed, for example, spent much of the 2010s hoping to get inflation up to target, while now, ironically, inflation in the U.S. has run above target for almost half a decade. Whether the lingering effects of the COVID inflation has affected the price-setting mechanism is unclear, as is whether tariff-driven inflation will exacerbate the situation.
4:21Arunima Sinha:Our read of the evidence is that inflation expectations and central bank credibility come from hitting the target, not from announcing it. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share thoughts on the market with a friend or colleague today. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.
From the publisher
Can a central bank simply announce an inflation target and get everyone to believe it? Our Global Economist Arunima Sinha looks at the cases of South Africa and Brazil to explain why it’s a subject of decades-long debate.
Read more insights from Morgan Stanley.
----- Transcript -----
Arunima Sinha: Welcome to Thoughts on the Market. I'm Arunima Sinha, Global Economist at Morgan Stanley.
Today I'm going to talk about how inflation targets of central banks matter for market participants and economic activity.
It's Tuesday, August 12th at 10am in New York.
Tariff driven inflation is at the center of financial market debates right now. The received wisdom is that a central bank should look through one-off increases in prices if – and it is an important if – inflation expectations are anchored low enough. Inflation targets, inflation expectations, and central bank credibility have been debated for decades.
The Fed's much criticized view that COVID inflation would be transitory was based on the assumption that anchored inflation expectations would pull inflation down. The Fed is more cautious now after four years of above target inflation. Can a central bank simply announce an inflation target and get everyone to believe it?
Far away from the U.S., the South Africa Reserve Bank, SARB, is providing a real time experiment. The SARB’s inflation target was originally a range of 3 to 6 per cent, with an intention to shift to 2 to 4 percent over time. At its last meeting, the SARB announced that it was going to target the bottom end of the range, de facto shifting to a 3 percent target. A decision by the Ministry of Finance in the coming months is likely necessary to formalise the outcome, but the SARB has succeeded in pulling inflation down. It has established credibility, but we suspect that more work is needed to anchor inflation expectations firmly at 3 percent.
Key to the SARS challenge, as the Fed’s – the central bank cannot control all the drivers of inflation in the short run. For South Africa, fiscal targets and exchange rate movements are prime examples. The experience in Brazil offers insight for South Africa. The BCB adopted an inflation target in 1999 following the end of the currency peg that helps the transition away from hyperinflation. The target was initially set at 8 percent, lowered to 4.5 percent in 2005, and then lowered again to 3 percent in 2024.Fiscal outcomes, market expectations, and currency volatility have been hard to contain. The lessons apply to South Africa and also the Fed. Successful inflation targeting relies on a clear framework, but also on institutional strength and political consensus.
For South Africa, as inflation falls ex-ante real interest rates will rise. That outcome will be necessary to restrain the economy enough to make sure that the path to 3 percent is achieved. For an open EM economy, there likely needs to be consistency by both monetary and fiscal authorities with regard to short-term pressures, both internal and external.
While we ultimately expect the SARB to be able to anchor inflation expectations, the journey may not be a quick one; and that journey will likely depend on keeping real interest rates on the higher side to ensure the convergence.
We take the experiences of South Africa and Brazil to be informative globally. Simply announcing an inflation target likely does not solve the problem. The Fed, for example, spent much of the 2010s hoping to get inflation up to target – while now ironically, inflation in the US has run above target for almost half a decade.
Whether the lingering effects of the COVID inflation has affected the price setting mechanism is unclear, as is whether tariff driven inflation will exacerbate the situation. Our read of the evidence is that inflation expectations and central bank credibility come from hitting the target, not from announcing it.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share thoughts on the market with a friend or colleague today.