INFLATION TARGETING AND THE FISHER EFFECT IN SOUTH AFRICA: AN EMPIRICAL INVESTIGATION

The paper analyses the relationship between expected inflation and nominal interest rates during a period of inflation targeting in South Africa, i.e. from 2000 to 2005. Specifically, it investigates the Fisher hypothesis that nominal interest rates move one‐to‐one with expected inflation, leaving the real interest rate unaffected. The analysis distinguishes between a short‐run Fisher effect and a long‐run Fisher effect. Using cointegration and error correction models (for monthly data for the period April 2000 to July 2005), it was found that the short‐run Fisher hypothesis did not hold during the relevant period under the inflation targeting monetary policy framework in South Africa. This is attributed to a combination of the South African Reserve Bank's (SARB) control over short‐term interest rates and the effects of the monetary transmission mechanism. The long‐run Fisher hypothesis could not be confirmed in its strictest form: while changes in inflation expectations move in the same direction as the nominal long‐term interest rate. This suggests that monetary policy has an influence on the real long‐term interest rate, which has positive implications for general economic activity, thus confirming the credibility of the inflation targeting framework.     

Inflation in South Africa: An Assessment of Alternative Inflation Models

We consider the relative empirical performance of a range of inflation models for South Africa. Model coverage is of Phillips curve, New Keynesian Phillips curve, monetarist and structural models of inflation. Our core findings are that the single most robust covariate of inflation is unit labour cost. We further decompose unit labour cost into changes in the nominal wage and real labour productivity. The principal association is a strong positive relationship between inflation and nominal wages, while improvements in real labour productivity report only a relatively weak negative association with inflation. Supply‐side shocks also consistently report an association with inflation. As to demand‐side shocks, the output gap does not return a robust statistical association with inflation. Instead, it is growth in the money supply and government expenditure which return robust and theoretically consistent associations with inflationary pressure.     

THE SOUTH AFRICAN PHILLIPS CURVE: HOW APPLICABLE IS THE GORDON MODEL?

Is there a Phillips curve relationship present in South Africa and if so, what form does it take? Traditionally the method to establish whether or not there is a relationship between the output gap and the change in inflation is merely to regress the latter on the former. This yields the well‐known augmented Phillips curve. However, Gordon has argued that this specification of the Phillips curve produces biased results. Instead, he puts forward and estimates successfully for several industrialised countries his so‐called triangular model that tests for hysteresis and inertia in the behaviour of inflation, as well as the impact on inflation of changes in the output level. This paper considers whether or not Gordon's triangle model is applicable to South Africa, i.e. are hysteresis and inertia present in South Africa? In addition, in an attempt to find a better estimation of the output gap, the paper also experiments with alternative ways to estimate the long‐run output level, including the standard HP‐filter, as well as a production function approach.     

Revisiting the Exchange Rate Pass‐Through to Inflation in Africa’s Two Largest Economies: Nigeria and South Africa

This paper revisits the exchange rate pass‐through (ERPT) to inflation in Nigeria and South Africa by incorporating structural breaks and using time series variables, namely the consumer price index, nominal effective exchange rate, gross domestic product, and crude oil price. Based on the Maki cointegration test and a flexible estimation approach of the Autoregressive Distributed Lag (ARDL) model, our empirical evidence suggests that the long‐ and short‐run ERPT to inflation is complete for Nigeria, while for South Africa it is incomplete both in the long run and short run. This result indicates that prices are stickier in South Africa compared to Nigeria. The comparison between Nigeria and South Africa confirms the role of inflation targeting and central bank credibility on the ERPT. The results divulge further that output growth in Nigeria increases inflation in the long run while it is anti‐inflationary in the short run. For South Africa, the effect of output growth is negatively insignificant. In addition, the long‐run effect of oil price is negative and significant for Nigeria, while for South Africa the short‐run effect of oil price is positive and significant. Therefore, the findings of this paper will assist the monetary authorities to achieve monetary policy objectives.     

Inflation and Inflation Expectations in South Africa: an Attempt at Explanation

This paper examines the relationship between inflation and inflation expectations in South Africa. We use inflation expectations derived from the quarterly surveys conducted by the Bureau of Economic Research from 2001Q1 to 2011Q4 . Using these data, we estimate the model assuming that private sector expectations are a linear function of the inflation target and lagged inflation. The results indicate that economic agents' expectations largely depend on lagged inflation. This suggests that the South African Reserve Bank (SARB) has not been successful in anchoring expectations of the private sector since the adoption of the inflation targeting (IT) regime in 2000. We also find evidence indicating that the SARB's implicit inflation target lies above the upper bound of the official IT band. Finally, it appears that the SARB has been more concerned about output stabilisation than inflation stabilisation.     

Reactions to Shocks and Monetary Policy Regimes: Inflation Targeting Versus Flexible Currency Board in Sub‐Saharan Africa

The paper examines the monetary policy actions through which central banks in sub‐Saharan Africa have tried to eliminate the negative impacts of the shocks facing their economies. We compare two different monetary policy regimes: a currency board regime (in the CFA zone) and an inflation targeting policy regime (Ghana and South Africa) when central banks respond to demand, supply, and fiscal shocks. We extend the usual forecasting and policy analysis system models to replicate the economic features of these economies during the period 2002–12 and to evaluate the impact of several policies in response to these shocks. We find that both policies are inappropriate in helping the economies escape from the effects of negative demand shocks, both are essential when negative shocks to primary balance occur, while inflation targeting dominates the currency board regime as a strategy to cope with positive shocks to inflation.     

Inflation-Output Trade-Off in South Africa: Is the Phillips Curve Symmetric?

This study sets out to investigate whether the inflation-output trade-off in South Africa is symmetric or asymmetric; and if asymmetric, whether it is convex or concave. A New Keynesian dynamic stochastic general equilibrium model calibrated on South African data reveals that a negative demand shock reduces inflation and output while a positive demand shock of the same magnitude leads to a smaller increase in inflation and a larger increase in output, indicating that the inflation–output relationship in the country is concave asymmetric. These findings corroborate estimation results of the inflation-expectations augmented Phillips curve conducted using difference GMM on quarterly data.     

MEASURING THE WELFARE COST OF INFLATION IN SOUTH AFRICA

In this paper, we estimate the long‐run equilibrium relationship between money balance as a ratio of income and the Treasury bill rate for the period of 1965:02 to 2007:01, and in turn use the relationship to obtain welfare cost estimates of inflation. Using the Johansen technique, we estimate a log‐log specification and a semi‐log model of the above relationship. Based on the fits of the specifications, we decided to rely more on the welfare cost measure obtained under the log‐log money demand model. Our estimates suggest that the welfare cost of inflation for South Africa ranges between 0.34% and 0.67% of GDP, for a band of 3‐6% of inflation. Thus, it seems that the South African Reserve Bank's current inflation target band of 3‐6% is not too poorly designed in terms of welfare.     

INFLATION IN SOUTH AFRICA: A TIME‐SERIES VIEW ACROSS SECTORS USING LONG‐RANGE DEPENDENCE

In this paper I examine the time‐series evolution of the log consumer price index series in South Africa, disaggregating the data by sectors. I examine the time period 1990m1‐2008m12, i.e. focusing on the post‐apartheid period. I used methodologies based on fractional integration using parametric and semiparametric techniques. The results indicate that the (total) inflation rate in South Africa is long memory, with an order of integration in the range (0, 0.5). The same happens with most of the data disaggregated by sectors with values of d above 1 in the log prices. Evidence of I(0) inflation is obtained in some cases for “fruits and nuts”, “vegetables” and “sugar”, and evidence of mean reversion in the log prices is only obtained in the case of “fish and other seafood”.     

Exchange Rate Policy and Currency Substitution: The Case of Africa's Emerging Economies

This paper examines the dynamic of currency substitution (CS) in Egypt and South Africa. The study also assesses the causal relationships of this phenomenon. There are three main CS‐related differences between the two countries. These are (1) the orientation of economic policy, (2) the degree and level of CS, and (3) the trend of CS. During the study period 1991‐2001, Egypt used the exchange rate as an anchor to its economic programme. While in the case of South Africa, the authorities directly targeted inflation. During this period, CS in Egypt started at a substantial level and experienced a steady decline. Conversely, CS in South Africa started at an insignificant level, but observed an uninterrupted increase. The results suggest that the elasticity of CS, with respect to exchange rate, of South Africa is 2.3 times that of Egypt, and that the speed of adjustment in South Africa is 5 times faster than in Egypt. Granger‐causality tests indicate a unidirectional relationship from the exchange rate to CS, in both Egypt and South Africa. The test for the interest rate differential and CS indicate that causality runs from the former to the latter in South Africa, but it runs in the opposite direction in Egypt. The study suggests that despite the cost of the exchange rate anchoring policy, it is more suitable to a high CS environment. Inflation targeting policy can be effective in achieving its objective as long as the CS is insignificant.     

MONETARY POLICY IN RWANDA: A COINTEGRATION ANALYSIS

Countries in Africa are increasingly becoming similar in outlook, especially as regards monetary policy. With a view to conducting a long‐term study of monetary policy in Africa, we apply an empirical test for the coherence of inflation targeting, first conducted by Nell (2003 ) for South Africa, to data from Rwanda. We find that like South Africa, Rwanda has a stable money demand function and the adoption of an inflation target is a wise policy option. Also, the Rwandan money market needs just over five quarters to eliminate half of any monetary disequilibrium. These results are of some interest to economists and policy makers for all the countries in the increasingly interconnected continent of Africa.     

Performance of land reform projects in the North West province of South Africa: Changes over time and possible causes

Anecdotal evidence as well as selected studies on the performance and progress of South Africa’s land reform programme generally present mixed to rather negative results. Few longitudinal studies exist on the progress of redistributed farms, resulting in an incomplete picture of the performance and progress of land reform projects. In this article, we report on the progress and performance of a group of land reform projects in the North West province of South Africa over five years. As part of a comprehensive audit of land reform projects in the North West province, 43 farms were studied in 2005 to assess their performance, based on their production status. Five years later, in 2010, 37 of these farms were visited again to review their progress. The results indicate that the production status (and thus performance) of land reform projects is not static. Although some projects either improved or maintained their initial production status, the overall trend shows deterioration in performance. Numerous factors are responsible for the decline, including group characteristics where farms are owned by groups of beneficiaries. This article is thus the first to use two surveys of a group of land reform projects to show the true status of farms in their post-transfer phase in South Africa.     

A Note on the (Continued) Ability of the Yield Curve to Forecast Economic Downturns in South Africa

In 2002‐2003, the South African yield spread falsely signalled a downswing that never materialised. This paper provides two reasons for this false signal. First, while the Reserve Bank never actually officially declared the start of a downswing, by alternative measures a downswing did actually occur. It is this severe weakness in economic activity at that time that the yield curve pointed to. Second, short‐term interest rates in 2003 were higher than they should have been because of a mistake made in measuring consumer price inflation. Because South Africa had recently introduced an inflation‐targeting regime, policy interest rates were, as a result of this error, kept too high for too long. This policy mistake was rectified as soon as the error in the Consumer Price Index was discovered. Thus, the yield curve in 2003 pointed to the reality that short‐term interest rates were too high and risked pushing the economy into full blown recession. This is demonstrated by the fact that it was a fall in long bond interest rates that caused the yield spread to turn negative, indicating expectations that short‐term interest rates would need to be cut – as indeed they were.     

China's impact on South African trade and inflation

There has been much controversy about the impact of Chinese growth on the rest of the world. It is generally accepted that China has a dampening effect on global inflation through the supply of cheap products. On the other hand, imports from China could displace domestic production and hence have adverse effects on economic growth and employment. Thus, the question of whether a country benefits from trading with China is a country-specific issue. The results in this paper indicate that limited short-term costs have resulted from the strengthening of trade relations between South Africa and China. As far as inflation is concerned, the paper does not find convincing empirical evidence at the aggregate level for inflation in China leading to domestic price changes. At the disaggregate level, however, there appear to be stronger sector-specific linkages between prices in China and South Africa.     

Has the Exchange Rate Pass‐Through changed in South Africa?

This paper uses the two‐stage exchange rate pass‐through (ERPT) framework instead of the direct pass‐through (PT) from the exchange rate to consumer inflation to assess the variation in the ERPT for South Africa from 1994 to 2014. The paper uses rolling‐window estimation to examine the possibility of change in the ERPT over time. In addition, it investigates the asymmetric behaviour of the ERPT over the business cycle. The results indicate that the ERPT for South Africa is complete in the first stage but incomplete in the second stage. It implies that retailers do not pass all the cost to consumers. The first‐stage ERPT has declined slightly since the Global Financial Crisis. Weak domestic demand and possibly the concentration of firms in the manufacturing sector are the main forces behind this low PT. Moreover, there is evidence of asymmetry in the first‐stage ERPT in that it tends to rise in the upturn phase of the economy compared to the downturn. The second‐stage ERPT shows a considerable decline since the adoption of the inflation‐targeting regime. Similar to the first‐stage case, the PT is muted in the downturn but rises in the expansionary phase by about 10%.     

HIGH AND VARIABLE INFLATION: FURTHER EVIDENCE ON THE FRIEDMAN HYPOTHESIS

This note, employing a GARCH model, finds a positive and significant relationship between the level and variability of inflation in South Africa in the period 1957:1‐2005:9. This provides evidence in support of Friedman's hypothesis that high inflation leads to more variable inflation.     

ON INFLATION

There is currently much more common sense in the South African inflation debate than a few decades ago. In particular, the South African Reserve Bank exhibits a pragmatic, eclectic approach to inflation (as reflected in its bi‐annual Monetary Policy Reports). This is in stark contrast to the narrow, monetarist‐type thinking that tended to dominate during the 1980s. This paper is an attempt to contribute to the debate by highlighting a few issues, including the widespread substitution of the CPI by the CPIX, the fact that inflation is a process, the need to combat inflation, the causes of the decline in inflation in South Africa and the essential features of an inflation‐targeting framework for monetary policy.     

COPING WITH INFLATION AND EXCHANGE RATE SHOCKS IN THE SOUTH AFRICAN ECONOMY

Over the past ten years South Africa has moved to an increasingly open economy, characterised by a (relatively) low inflation and large and unpredictable movements in the prices of financial assets. One of these asset prices is the value of the South African currency. This volatility in the exchange rate has a direct impact on inflation. Using the interest rate as operational target, a central bank might ignore or underestimate the exchange rate transmission mechanism through which the economy is influenced. This paper proposes a Monetary Conditions Index for South Africa that can be used as a policy rule or simply as an important information variable in conducting monetary policy under an inflation‐targeting regime with a volatile exchange rate.     

THE RELATIONSHIP BETWEEN TOURISM AND TRADE IN SOUTH AFRICA

This article explores the relationship between tourist arrivals and trade in South Africa. Two analyses were conducted – a panel data analysis, which included tourism and trade data of 40 countries with South Africa, and a time‐series analysis that involved South Africa's main tourism and trade partners. Cointegration tests, Granger causality and Block exogeneity tests were used to investigate the nature of the relationship. The results of the panel data analysis show that for South Africa as a whole, there is indeed a long‐term relationship between tourist arrivals and trade, and that bidirectional causality exists. The results for the country case studies are mixed, although the evidence is stronger for the hypothesis that tourism causes trade.     

Public Debt,Economic Growth and Inflation in African Economies

We analyse the relationship between public debt, economic growth and inflation in a group of 52 African economies between 1950 and 2012. The results indicate that the limits of public debt are negatively related to economic growth and exhibit, from a given level of debt, an inverted U behaviour regarding the relationship between economic growth and public debt. Briefly, the high levels of public debt are coincident with reduced rates of economic growth and rising levels of inflation. Our results for three specific geographical areas resemble those of the overall analysis, despite some differences. In North African countries, the growth rates of the gross domestic product (GDP) and inflation also show an inverted U behaviour as the ratio of public debt/GDP increases. The highest rate of economic growth is recorded when the ratio of public debt/GDP is below 30% of GDP and corresponds to an average inflation rate of 5.33%. An identical behaviour of the GDP growth rates and inflation also appears in Sub‐Saharan countries until the third interval (60–90%). However, the highest growth rate of the GDP and GDP per capita is registered when the public debt/GDP ratio is in the second interval (30–60%). For the countries of the Southern Africa Development Community, the highest average rate of economic growth (6.8%) is similar to North African countries, when the ratio public debt/GDP is below 30% of GDP, with an average inflation rate of 11%. A number of robustness analyses were performed and the great majority of them confirm the general analysis.