Rethinking the current inflation target range in South Africa

Bonga-Bonga, Lumengo and Lebese, Ntsakeseni Letitia (2016): Rethinking the current inflation target range in South Africa.

Abstract

With critics suggesting that inflation targeting is not an appropriate monetary policy framework for developing and emerging countries, this paper assesses whether or not the 3%-6% inflation target is the optimal inflation target band in South Africa. The optimal inflation target band is determined based on the time-varying non-accelerating inflation rate of unemployment (the NAIRU). The estimation results provide an estimated inflation range that is wider than the current range pursued by the South African Reserve Bank. This may suggest that the current range of inflation hinders real activities, especially employment in South Africa.

• Item Type: MPRA Paper
• Language: English
• Keywords: inflation target, NAIRU, unemployment, South Africa
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C13 - Estimation: General; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

Arkerlof, G.A., Dickens, W.T., Perry, G.L., Gordon, R.J., and Mankiw, N.G. (1996). The macroeconomics of low inflation. Brookings Papers on Economic Activity, Vol.1999, No.1, pp. 1 – 76.

Arkerlof, G.A., Dickens, W.T., Perry, G.L., Bewley, T.F., and Blinder, A.S. (2000). Near-Rational Wage and Price Setting and the Long-Run Phillips Curve. Brookings Papers on Economic Activity, Vol. 2000, No.1, pp. 1 – 60.

Ball, L. Mankiw, N.G. and Nordhaus, W.D. (1999). Aggregate Demand and Long-run Unemployment. Brookings Papers on Economic Activity, Vol. 1999, No. 2, pp. 189 – 251.

Ball, L. and Mankiw, N.G. (Fall, 2002). The NAIRU in theory and practice. Journal of Economic Perspectives, Vol. 16, No. 4, pp. 115 – 136.

Banerjee, A., Galioni, S., Levinsohn, J. McLaren, Z. and Woolard, I. (June, 2007). Why has unemployment risen in the new South Africa? National Bureau of Economic Research, NBER Working Paper Series, Working Paper No. 13167.

Banerjee, A., Galioni, S., Levinsohn, J. McLaren, Z. and Woolard, I. (2008). Why has unemployment risen in the new South Africa? Economics of Transition, Vol. 16, No. 4, pp. 715 - 740.

Bernanke, B.S, Laubach, T.S. and Mishkin, F.S. (1999). Inflation targeting. Princeton, Princeton university Press.

Bernanke, B.S. (2003). Panel discussion, October 17. www.federalreserve.gov/boarddocs/speeches/2003. Accessed 12 Decembre 2015.

Bonga-Bonga, L. and Kabundi, A. (2011). Monetary policy action and inflation in Siuth aFrica: an empirical analysis, African Finance Analysis, 13(2): 25-37.

Boone, L., Giorno, C., Meacci, M., Rae, D., Richardson, P. and Turner, D. (2003). Estimating the structural rate of unemployment for the OECD countries. OECD Economic Studies, Vol. 2002/2, No. 33, pp. 172 - 211.

Burger, P. and Marinkov, M. (2006). The South African Phillips curve: How applicable is the Gordon model? South African Journal of Economics. Vol. 74, No. 2, pp. 172 – 189.

Casteleijn, A.J.H. (June, 1999). The Viability of Implementing an Inflation Targeting Monetary Policy Framework in South Africa. Pretoria: South African Reserve Bank.

Department of Economic Development (2010). New Growth Path Framework. Pretoria: Department of Economic Development.

Department of Finance (1996). Growth, Employment and Redistribution: A Macroeconomic Strategy. Pretoria: Department of Finance.

Du Plessis, S. and Burger, R. (2006). A New Keynesian Phillips Curve for South Africa. Paper presented at the South African Reserve Bank Conference, Pretoria.

Ehler, N. and Steinbach, R (2007). The formation of inflation expectations in South Africa. Working paper no. 3243, South African Reserve Bank.

Erceg, C.J. (May, 2002). The Choice of an Inflation Target Range in a Small Open Economy. AEA Papers and Proceedings, Vol. 92, No. 2, pp. 85 – 89.

Fedderke, J.W. and Schaling, E. (March, 2005). Modelling Inflation in South Africa: A multivariate cointegration analysis. South African Journal of Economics. Vol. 73, No. 1, pp. 79 - 92.

Fischer, S. (1996). Why are central banks pursuing long-run price stability? Kansas City: Federal Reserve Bank of Kansas City.

Fortin, P. (Feb., 2001). Inflation targeting: the three percent solution. Policy Matters, Vol. 2, No. 1, pp. 1 – 16.

Fraga, A., Goldfajn, I., and Minella, A. (October, 2003). Inflation targeting in emerging market economies. National Bureau of Economic Research, NBER Working Paper Series, Working Paper No. 10019.

Friedman, M. (March, 1968). The Role of Monetary Policy. The American Economic Review, Vol. 58, No. 1, pp. 1 - 17.

Gordon, R.J. (Winter, 1997). The time-varying NAIRU and its implications for economic policy. Journal of Economic Perspectives, Vol. 11, No. 1, pp. 11 – 32.

Gupta, R. and Uwilingiye, J. (February, 2008). Measuring the Welfare Cost of Inflation in South Africa. Economic Research Southern Africa, Working Paper No. 68.

Hodge, D. (2002). Inflation versus unemployment in South Africa: Is there a trade-off? South African Journal of Economics, Vol.70, No.3, pp. 418 – 443.

Holden, S. (April, 2002). The costs of price stability – downward nominal wage rigidity in Europe. The National Bureau of Economic Research, Working Paper No. 8865, pp. 1 - 41.

Hsing, Y. (2009). Estimating the time-varying NAIRU for Germany and policy implications. Applied Economic Letters, Vol. 16, No. 5, pp. 469 – 473.

Kabundi, A.; Schaling, E. and Some, M. (2015). Estimating a Phillips Curve for South Africa: A Bounded Random Walk Approach. ERSA working paper no. 568.

Kahn, B. (2008). Challenges of Inflation Targeting for Emerging-market Economies: The South African Case. Paper presented for the South African Reserve Bank Conference Series on Challenges for monetary policy-makers in emerging markets, Pretoria.

Kaminsky, G.L. ; Reinhart, C.M. and Vegh, C.A. (2005). Whe it rains, it pours: procyclical capital flow and macroeconomic policies, in NBER macroeconomic Annual 2004, Vol.19, ed. By Gertler, M. and Rogoff, K., Cambridge: NBER.

Karanassou, M., Sala, H. & Snower, D.J. (2010). Phillips curves and unemployment dynamics: A critique and holistic perspective. Journal of Economic Perspectives, Vol. 24, No. 1, pp. 1 - 51.

Klasen, S. and Woolard, I. (2008). Surviving Unemployment without State Support: Unemployment and Household Formation in South Africa. Journal of African Economies, Vol. 18, No. 1, pp. 1 – 51.

Leshoro, T.L.A. (May, 2012). Estimating the inflation threshold for South Africa. Economic Research Southern Africa. ERSA, Working Paper 285.

Levin, A.T., Natalucci, F.M. and Piger, J.M. (2004). The macroeconomics effects of inflation targeting. Conference proceeding of the 28th annual economic policy conference on “Inflation Targeting: Prospects and Problems” held in St Loius. Conducted by the Federal Reserve Bank of St Louis. St Louis: Federal Reserve Bank of St Louis.

Lundborg, P. and Sacklẻn, H. (2006). Low-inflation targeting and long-run unemployment. The Scandinavian Journal of Economics, Vol. 108, No. 3, pp. 397 – 418.

Mackowiak, B. (2007). External shocks, US monetary policy shocks and macroeconomic fluctuations in emerging market. Journal of monetary economics, 54(8): 2512-2520.

Mankiw, N.G. (May, 2001). The Inexorable and Mysterious Trade-off between Inflation and Unemployment. The Economic Journal, Vol.111, No. 471, pp. C45 – C61.

Maugeri, N. (2010). Macroeconomic Implications of Near Rational Behaviour: An Application to the Italian Phillips Curve. Unpublished doctoral thesis. Siena: Università di Siena.

Mboweni, T.T. (December, 1999). Inflation targeting in South Africa. The South African Journal of Economics, Vol. 67, No.4, pp 401 - 409.

McCord, A. and Bhorat, H. (2003). Employment and Labour Market Trends. In Human Resources Development Review. Edited by Kraak, A. and Perold, H. Cape Town: HSRC Press.

Michie, J. (Oct., 2003). The Institutional Underpinnings of the Unemployment-Inflation Relationship: A Review Paper. Pretoria: Human Sciences Research Council.

Mishkin, F.S. and Westelius, N.J. (2008). Inflation Band Targeting and Optimal Inflation Contracts. Journal of Money, Credit and Banking, 40(4): 557-582

National Labour and Economic Development Institute. (2004). Highlights of the current labour market conditions in South Africa. Johannesburg: National Labour and Economic Development Institute.

Nell, K.S. (2002). Is low inflation a precondition for faster growth? The case of South Africa. University of Kent, Department of Economics, Working Paper No. 0011.

Padayachee, V. (2001). Central bank transformation in a globalized world: The Reserve Bank in post-apartheid South Africa. Journal of International Development, Vol. 13, pp. 741 – 765.

Phillips, A.W. (November 1958). The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861 – 1957. Economica, Vol.25, No.100, pp. 283-299.

Phiri, A. (2010). At what level is inflation least detrimental towards finance-growth activity in South Africa? Journal of Sustainable Development in Africa, Vol.12, No. 6, pp. 354 – 364.

Pretorius, C.J. and Smal, M.M. (March1994). A macro-economic examination of the price-formation process in the South African economy. The South African Reserve Bank Quarterly Bulletin No. 191, pp. 25 – 36.

Ricci, L.A. (2005). Bringing inflation under control. In Post-Apartheid South Africa: The First Ten Years. Edited by Nowak, M. and Ricci, L.A. Washington: International Monetary Fund.

Rossouw, J. and Padayachee, V. (April, 2008). An Analysis of inflation from a central banking perspective: The South African experience since 1921. University of Kwazulu Natal: School of Development Studies. Working Paper No. 50.

Staiger, D., Stock, J.H. and Watson, M.W. (Winter 1997). How Precise are Estimates of the Natural Rate of Unemployment? The Journal of Economic Perspectives, Vol. 11, No. 1, pp. 34 – 49.

Svenssons, L.E.O. (Aug., 1999). Price-level targeting versus inflation targeting: A free lunch? Journal of Money, Credit and Banking, Vol. 31, No. 3, pp. 277 – 295.

Van der Merve, E.J. (July, 2004). Inflation targeting in South Africa. The South African Reserve Bank Occasional Paper No. 19.

Viegi, N. (2015), LabourMarket andMonetary Policy in South Africa. SARB Working Paper 15/01.

World Bank (2015). World Development Indicators. http://beta.worldbank.org. accessed 27 january 2016.

Wyplosz, C. (2000). Do we know how low should inflation be? Conference proceeding of the first Central Banking Conference on “Why Price Stability” held in Geneva. Conducted by the European Central Bank. Geneva: Graduate Institute of International Studies.