Monetary policy and inflation in South Africa: A VECM augmented with foreign variables

Annari De Waal and Renee van Eyden ()

No 201231, Working Papers from University of Pretoria, Department of Economics

Abstract: We develop a structural cointegrated vector autoregressive (VAR) model with weakly exogenous foreign variables, suitable for a small open economy like South Africa. This type of model is known as an augmented vector error correction model (VECM), referred to by VECX*. We compile the foreign variables with trade-weighted three-year moving average data for 32 countries, to account for the significant change in trade shares over time. This model is novel for South Africa, in two ways: it is the first VECX* developed to analyse monetary policy in the country and the first model that uses time-varying trade weights for the creation of the foreign series. We find three significant long-run economic relations: the augmented purchasing power parity, the uncovered interest parity and the Fisher parity. These long-run relations are imposed on the VECX* to investigate the effect of a monetary policy shock on inflation. The results suggest the effective functioning of the monetary transmission mechanism in South Africa.

Keywords: South Africa; monetary policy; structural cointegrated vector autoregressive model; augmented VECM; VECX* (search for similar items in EconPapers)
JEL-codes: C50 E52 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2012-10
New Economics Papers: this item is included in nep-mon
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Citations: View citations in EconPapers (2)

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Journal Article: Monetary policy and inflation in South Africa: A VECM augmented with foreign variables (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:pre:wpaper:201231

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