Exchange Rate Pass-Through and Monetary Policy in South Africa

Abstract:     
Understanding how import prices adjust to exchange rates helps anticipate inflation effects and monetary policy responses. This paper examines exchange rate pass-through to the monthly import price index in South Africa during 1980-2009. A methodological innovation allows various short-run pass-through estimates to be calculated simply without recourse to a full structural model, yet without neglecting the long-run relationships between prices or the effects of previous import price changes, and controlling for domestic as well as foreign costs. Pass-through is incomplete at about 50 percent within a year and 30 percent in six months, averaging over the sample. Johansen analysis of a cointegrated system using impulse response functions largely supports these short-run results, but as it includes feedback effects, implies lower pass-through for exogenous exchange rate shocks. Equilibrium pass-through, ignoring feedback effects, is around 75 percent. Shifts in pass-through with trade and capital account liberalisation in the 1990s are explored. There is evidence of slower pass-through under inflation targeting when account is taken of temporary shifts to foreign currency invoicing or increased hedging after large exchange rate shocks in the period. Further, pass-through is found to decline with recent exchange rate volatility and there is evidence for asymmetry, with greater pass-though occurring for small appreciations.

Number of Pages in PDF File: 48

Keywords: asymmetic pass-through, exchange rate pass-through, exchange rate volatility, falling pass-through, import prices, monetary policy, South Africa, trade openness

JEL Classification: C22, C32, C51, C52, E3, E52, F13

working papers series