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Inflation, Output and Monetary Policy in South Africa

Harold Ngalawa and Coretha Komba
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Coretha Komba: University of KwaZulu Natal

Working Papers from African Economic Research Consortium, Research Department

Abstract: South Africa adopted inflation targeting as its monetary policy framework in February 2000. The country’s monetary authorities, however, have struggled to keep inflation within the targeted 3%-6% band. A review of the literature reveals that an understanding of the inflation-output trade-off is essential for the achievement of price stability. The effects of policy may be different depending on whether the inflation-output trade-off is symmetric or asymmetric; and when it is asymmetric, the outcome may vary contingent on whether the asymmetry is convex or concave. In South Africa, the nature of this relationship is not known. Estimation of the inflation-expectations augmented Phillips curve using the difference Generalized Method of Moments on quarterly time series data for the period 2000:3 to 2015:1 reveals that South Africa’s Phillips curve is concave asymmetric. These estimation results, however, may not be policy-invariant because they are obtained from “highly” aggregated historical data and the model parameters are not structural. Consistent with the Lucas Critique, we formulate a New Keynesian dynamic stochastic general equilibrium model calibrated on South African data. Simulation results of the model show 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, confirming the concave asymmetric inflation-output relationship found earlier. Concavity of the Phillip’s curve implies declining sensitivity of inflation to the strength of the economy, suggesting that any given change in inflation requires an increasingly larger adjustment in output.

Date: 2020
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
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