An Investigation of the Relationship between Oil Prices and Inflation in South Africa

Abstract

It is widely believed that the increase in the real price of oil early 1970s was a major cause of high inflation and recession. In recent years, oil prices have been rising and its economic impact is an issue that continues to attract more attention globally and South Africa in particular. An increase in oil price and related goods causes a shift in the aggregate supply curve that results in higher price level. This paper uses Augmented Dickey-Fuller technique in testing the unit root property of the series, Johansen-Juselius Cointegration methods for testing long-run relationship between oil prices and inflation. The result showed that there is co-integrating relationship between oil price and inflation for South African data. Further effort was made to check the causality relationship that exists between the two variables by employing the Granger causality at two and four lag periods. The results showed the same at different lags. The first test was conducted using lag two (2) and in the result unidirectional causality was seen running from oil price to inflation. Further test at lag four (4) was carried out and it only supported the first by also indicating a unidirectional causality running from oil price to inflation. Policy implications and suggestion for future research are made in the paper. DOI: 10.5901/mjss.2013.v4n6p105