Monetary Policy Instrument and Inflation in South Africa: Structural Vector Error Correction Model Approach

Bonga-Bonga, Lumengo and Kabundi, Alain (2015): Monetary Policy Instrument and Inflation in South Africa: Structural Vector Error Correction Model Approach.

Abstract

Since the adoption of inflation rate targeting policy, there has been a great concern on the effectiveness of monetary policy to curb inflation in South Africa. The effectiveness of the repo rate as a policy instrument to control the level of inflation has been widely criticised not only in the South African context but also internationally. With the critics pointing out from a substantial lag for monetary policy changes to affect inflation to the inability of the policy instrument to effectively affect inflation level. In assessing the effectiveness of the monetary policy in South Africa, this paper makes use of the structural vector error correction model (SVECM) to characterise the dynamics of inflation to monetary policy shocks. The results of the impulse response function obtained from the SVECM found that while positive shocks to monetary policy decrease output but do not decrease credit demand and inflation in South Africa.

• Item Type: MPRA Paper
• Language: English
• Keywords: Inflation rate targeting, Policy instruments, Structural Vector Error Correction Model.
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

BALL, L., and SHERIDAN, N. (2005). Does Inflation Targeting Matter? In The Inflation Targeting Debate, edited by B. S. Bernanke and M. Woodford, 249–276.

BERNANKE, B. S., LAUBACH, T. MISHKIN, F. S. and Posen, A. S. (1999). Inflation Targeting: Lessons fromthe International Experience. Princeton University Press.

BERNANKE, B.S. and WOODFORD, M. (1997). Inflation Forecasting and Monetary Policy. Journal of Money, Credit and Banking, 29, 653-684.

BREITUNG, J., R. BRUGEMANN, and LUTKEPOHL, H. (2004). Structural Vector autoregressive modelling and Impulse Response Function in Applied Time Series Econometrics. In: H. Lütkepohl and M. Kräzig (eds.), Applied Time Series Econometrics, Cambridge: Cambridge University Press.

CASTELNUOVO, E., S. NICOLETTI-ALTIMARI, and RODRÍGUEZ PALENZUELA, D. (2003). Definition of Price Stability, Range, and Point Targets: The Anchoring of Long-Term Inflation Expectations. In Background Studies for the ECB’s Evaluation of Its Monetary Policy Strategy, edited by O. Issing, 43–90.

CORBO, V., O. LANDERRETCHE, and SCHMIDT-HEBBEL, K. (2002). Does Inflation Targeting Make a Difference? In Inflation Targeting: Design, Performance, Challenges, edited by N. Loayza and R. Soto, 221–69. Santiago: Central Bank of Chile.Neumann and von Hagen.

EPSTEIN, G. and YELDAN, E. (2007). Developing Policy Alternatives to Inflation Targeting: The New Façade of Neoliberal Conditionality. Political Economy Research Institute, mimeo.

FRIEDMAN, M., and SCHWARTZ, A.J. (1963). A Monetary history of the United States, 1867- 1960. Princeton: Princeton University Press for NBER.

GUPTA, R., and KOMEN, K. (2008). Time Aggregation and the Contradictions with Causal Relationships: Can Economic Theory Come to the Rescue? University of Pretoria Working Paper 2008-02.

GÜRKAYNAK, R., A. LEVIN, A. MARDER, and SWANSON, E. (2007). Inflation Targeting and the Anchoring of Inflation Expectations in the Western Hemisphere. In Monetary Policy under 28 Inflation Targeting, edited by F. Mishkin and K. Schmidt-Hebbel. Santiago: Central Bank of Chile.

HALL, P. (1992). The Bootstrap and Edgeworth Expansion,. New York: Springer-Verlag. HYVONEN, M. (2004). Inflation Convergence across Countries. Discussion paper 2004-04. Sydney: Reserve Bank of Australia.

IMF (2005). World Economic Outlook. International Monetary Fund, September, 161–186.

JOHANSEN, S. (1995). Likelihood-Based Inference in Cointegrated Vector Autoregressive Models. Oxford: Oxford University Press.

JOHNSON, D. R.(2002). The Effect of Inflation Targeting on the Behavior of Expected Inflation: Evidence from an Eleven-Country Panel. Journal of Monetary Economics 49(8), 1493–519.

JOHNSON, D. R.(2003,). The Effect of Inflation Targets on the Level of Expected Inflation in Five Countries. Review of Economics and Statistics 55(4), 1076–81.

LEVIN, A., F. M. NATALUCCI, and PIGER, J. M. (2004). The Macroeconomic Effects of Inflation Targeting. Federal Reserve Bank of St. Louis Review, 86(4), 51–80.

MBOWENI, T. (2008). Statement of the Monetary Policy Committee. January 2008, South African Reserve Bank.

MISHKIN, F.S. (2002). From Monetary Targeting to Inflation Targeting: Lessons from Industrialised Countries. In Banco de Mexico, Stabilization and Monetary Policy: The International Experience (Bank of Mexico: Mexico City, 2002), 99-139.

MISHKIN, F.S. and Schmidt-Hebbel, K. (2007). Does Inflation Targeting Make a Difference? NBER Working Papers 12876.

NADAL DE SIMONE, F. (2001). Inflation Targeters in Practice: A Lucky Lot?. Contemporary Economic Policy 19, 239-253.

ROGER, S., and STONE, M. (2005). On Target? The International Experience with Achieving Inflation Targets. IMF Working paper 05/163.

ROMER, C.D., and ROMER, D.H ( 1989). Does Monetary Policy Matter?: A New test in the Spirit of Friedman and Schwartz. NBER Macroeconomics Annual, 4, 121–170.

ROGOFF, K. (2006). Implication of Globalization Monetary Policy. In Federal Reserve Bank of Kansas City, The New Economic Geography: Effects and Policy Implications, Papers and Proceeding of2006 Jackson Hole Symposium.

VEGA, M., and WINKELRIED, D. (2005). Inflation Targeting and Inflation Behavior: A Successful Story? International Journal of Central Banking, Vol. 1(3), 153-175.