Exchange Rate Volatility and Pass-Through to Inflation in South Africa

Abstract

Does the South African rand's relatively large volatility affect inflation? To shed some light on this question, a standard estimation technique of exchange rate pass-through to inflation is extended to incorporate exchange rate volatility. Estimated results suggest that higher exchange rate volatility tends to increase core inflation but to a relatively limited extent in South Africa. The finding lends support to the policy of allowing the rand to float freely and work as a shock absorber, consistent with the nation's successful inflation targeting regime.

Keywords: Unit labor cost, Exchange rate policy, Exchange rate pass-through, Exchange policy, Exchange rate shocks, exchange rate volatility, inflation, WP, core inflation, volatility, SARB, output gap, rand

JEL Classification: E31, E58, F31, O24, E52, E01, Q02