Will the SARB always succeed in fighting inflation with contractionary policy?

Guangling Liu ()

No 15/2011, Working Papers from Stellenbosch University, Department of Economics

Abstract: The conventional view is that a monetary policy shock has both supply-side and demand-side effects, at least in the short run. Barth and Ramey (2001) show that the supply-side effect of a monetary policy shock may be greater than the demand-side effect. We argue that it is crucial for monetary authorities to understand whether an increase in expected future inflation is due to supply shocks or demand shocks before applying contractionary policy to forestall inflation. Using a standard New Keynesian dynamic stochastic general equilibrium model with the cost-channel of monetary transmission, we show that whether the South African Reserve Bank should apply contractionary policy to fight inflation depends critically on the nature of the disturbance. If an increase in expected future inflation is mainly due to supply shocks, the South African Reserve Bank should not apply contractionary policy to fight inflation, as this would lead to a persistent increase in inflation and a greater loss in output.

Keywords: Monetary policy; price puzzle; inflation targeting; New Keynesian model (search for similar items in EconPapers)
JEL-codes: E12 E31 E52 E58 (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-afr, nep-cba, nep-mac and nep-mon
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Journal Article: Will the Sarb always Succeed in Fighting Inflation with Contractionary Policy? (2013)
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