Abstract
This study is premised on investigating the effectiveness of inflation targeting in South Africa. The methods of analysis include the Vector Autoregressive model (VAR), the unit root test and cointegration test. The analysis was conducted with the use of EViews version 9. The findings from the study revealed that the response of inflation is not consistent with the Taylor rule hence increases in the repo rate meant to reduce inflation actually increase the inflationary pressures in the economy. This is due to the composition of the Consumer Price Index. Housing constitutes the largest weight on the CPI hence this has an impact on how the Repo rate affects inflation. The autoregression model of inflation showed that the sum of the coefficients is less than one (0.965) showing that inflation targeting has effectively reduced the persistence of inflation in South Africa. Thus monetary framework in South Africa seems to be effective and should thus be advanced for wider economic benefit.
Highlights
The ultimate objective of monetary policy in South Africa is to institute a stable financial environment that supports sustainable real economic growth over the medium and long term [1]
[3] adds that the assumption of forward looking monetary policy has been widely criticized by various scholars who argued that economic agents are not forward looking when making economic decisions
The results showed that forward-looking rules encompassed in the inflation targeting framework contribute to macroeconomic stability and monetary policy credibility, and that a positive inflation target, as opposed to zero inflation, leads to higher and less volatile output
Summary
The ultimate objective of monetary policy in South Africa is to institute a stable financial environment that supports sustainable real economic growth over the medium and long term [1]. This is achieved through maintaining a low inflation rate that has no material effects on the macroeconomic decisions of economic agents. The implementation of inflation targeting is based on the theory of rational expectations This theory assumes that economic agents set wages and prices based on expectations of future prices [3]. Critics argue that monetary policy instruments under an inflation targeting regime would be ineffective when the necessary preconditions do not prevail [2]
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