An empirical analysis of exchange rate pass-through to prices in South Africa
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Date
2017
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Publisher
University of Zululand
Abstract
The South African Reserve Bank (SARB) adopted an inflation targeting monetary policy with the effect from the 2000 in an attempt to curb inflation in the country. The band that was adopted was that of a minimum of 3% and a maximum of 6%. The main problem to the current monetary policy is the monthly inflation and other provincial inflation rates that are sometimes going outside the upper band of the target. Finding the duration taken by the price indices to respond to exchange rate fluctuations took a central interest to this research and also to find out the magnitude of the exchange rate fluctuations that are passed on to prices. This research did a comparative analysis from a SVAR and Recursive VAR to investigate exchange rate pass-through (ERPT) to tradable prices in South Africa for the period 2002-2015. Using monthly data, both estimations find the producer price index as the most contributing factor to inflation with an average of 22% of exchange rate fluctuations passed to prices. The argument behind the high pass-through in producer prices is mainly because of the high volumes of intermediate goods that are imported by the South African producers for local production. The results reveal that the impulse response functions are not very strong but the prices do not take long to respond to any exchange rate changes. We find that prices respond within 2 months to fluctuations in the exchange rate. It takes between 3 to 4 months for other price indices to respond to import prices. Also there is reverse causation on all the variables in the model but the magnitude differs from one variable to another. Large and persistent ERPT especially on import and producer prices accompanied by high wage demands and a depreciating currency are worrying factors for South Africa. Monetary policy makers are advised to put in place targeting measures on the exchange rate if inflation could be kept under control. Since inflation expectations play a pivotal role on inflation, it is wise for the upper band to be increased probably by 1% so that high inflation expectations that are influenced by inflation that is sometimes going outside the upper band can be held down.
Description
A dissertation submitted to the Faculty of Commerce, Administration and Law in fulfillment of the requirements for the Degree of Master of Commerce (Economics) in the Department of Economics at the University Of Zululand, 2017
Keywords
monetary policy --South Africa