To Reduce Inflation: New Application of Old Theories

Abstract

The international financial crisis of 2008 had a major impact on capital flows from developed countries to BRICS countries. This study explores the reasons and impact of capital and exchange rate volatility that BRICS countries experienced. The rethinking of inflation theory to address the capital volatility which emerging economies face is of utmost importance. International investors invest in South Africa and other BRICS countries and are of an exogenous nature. The solution to reduce the negative impact of capital and exchange rate volatility lies with a different inflation management in each BRICS country and a reduced interest rate spectrum. The root causes of the capital volatility were investigated and not the symptomatic mechanisms to reduce the impact. This research focused on the South African inflation scenario. A new inflation index is proposed for South Africa to reduce the negative impact of capital volatility in the South African economy. The new index which excludes all exogenous factors will allow National Treasury to introduce a much lower inflation target for the monetary authority to manage. The interest rate differential of South Africa will narrow significantly relative to developed economies. The reduced interest spectrum will also bring other advantages, for example to stimulate real growth, to increase employment opportunities and to contribute towards a reduction in poverty.

DOI: 10.5901/mjss.2014.v5n21p313