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

Guangling Liu ()

No 275, Working Papers from Economic Research Southern Africa

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. We estimate a standard New Keynesian dynamic stochastic general equilibrium model with the cost channel of monetary policy for the South African economy to 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. Our estimation results also show that, with a moderate level of cost-channel effect and nominal rigidities, a New Keynesian dynamic stochastic general equilibrium model with the cost channel of monetary policy is able to mimic the price puzzle produced by an estimated vector autoregressive model.

Keywords: Monetary policy; price puzzle; inflation targeting; New Keynesian model; Bayesian analysis (search for similar items in EconPapers)
JEL-codes: E52 E31 E58 E12 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2012
New Economics Papers: this item is included in nep-afr, nep-mac and nep-mon
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Related works:
Journal Article: Will the Sarb always Succeed in Fighting Inflation with Contractionary Policy? (2013) Downloads
Working Paper: Will the SARB always succeed in fighting inflation with contractionary policy? (2011) Downloads
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