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Monetary Policy and Inflation Modeling in a More Open Economy in South Africa

31 Pages Posted: 2 Dec 2008  

Janine Aron

University of Oxford - Department of Economics

John Muellbauer

University of Oxford - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: October 2008

Abstract

South Africa in the 1990s became globally more integrated after years of isolation. Opening the trade and capital accounts gave impetus to a monetary policy regime change to inflation targeting from 2000, after a costly transitional period of monetary mismanagement with low policy transparency. Changes in openness can, however, disrupt the inflation forecasting on which targeting monetary policies depend. This chapter demonstrates how the central bank's own producer price inflation equation in its core model can be improved by taking account of greater openness, using both innovative time-series openness measures and a more conventional measure. The model has a greatly improved fit and stability over longer samples when also including the real exchange rate and the interest rate differential (making explicit the exchange rate channel of monetary transmission) and asymmetric food price inflation. Moreover, there is a role for the level of the output gap rather than simply a short-run effect, as in the central bank's model. This helps mitigate the arguments in current South African debate regarding the apparent unconcern of inflation targeting policy for the level of economic activity.

Keywords: inflation dynamics, modelling producer prices, trade openness

JEL Classification: C22, E31, F13, F41

Suggested Citation

Aron, Janine and Muellbauer, John, Monetary Policy and Inflation Modeling in a More Open Economy in South Africa (October 2008). CEPR Discussion Paper No. DP6992. Available at SSRN: https://ssrn.com/abstract=1308063

Janine Aron

University of Oxford - Department of Economics ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom
+44 1865 271 084 (Phone)
+44 1865 271 094 (Fax)

John Muellbauer (Contact Author)

University of Oxford - Department of Economics ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom
+44 1865 278 583 (Phone)
+44 1865 278 557 (Fax)

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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