Does the Repurchase Rate Affect Inflation in South Africa? An Empirical Analysis Using an Impulse Response Function

Temitope L.A Leshoro

doi:10.22610/jebs.v6i7.513

Abstract

The repurchase rate (repo rate) is the most common monetary policy instrument that the South African Reserve Bank (SARB) uses to control inflation and endeavours to keep it within the inflation target band of 3% to 6%. This study examines the effect of the repo rate on inflation rate along with other variables using the Impulse-Response Function (IRF) of a Vector Autoregressive (VAR) technique. This study uses quarterly data spanning over the period 1980Q2 to 2013Q3. The response of a shock in repo rate on inflation rate and vice versa is generally positive. The results show that given one standard deviation shock in the repo rate, inflation rate will initially increase up until the second quarter after which it starts to decline, and increases again in the fifth quarter. The results obtained from the VAR granger causality test show that repo rate leads the gross domestic product (GDP) growth and inflation rate. There is bidirectional causality between inflation and repo rate; and the result is the same, even after structural break was accounted for. The VAR shows no evidence of instability and autocorrelation, hence the results are reliable. The study suggests some policy recommendations.

Highlights

The issue around the effectiveness of the repurchase rate in regulating inflation rate has been a major concern in South Africa
All the variables were first tested for stationarity and it was found that they were all integrated of order zero, I(0), that is they were all stationary at levels, the use of vector autoregressive (VAR) is appropriate
The impulse-response function (IRF) shows that it will take about nine quarters for inflation rate to fully become stable. This means that in the event of high inflation and the South African Reserve Bank (SARB) decides to apply a contractionary monetary policy by increasing the repo rate, it should be aware of the fact that this action will take approximately nine quarters before inflation returns to a stable position

Summary

Introduction

The issue around the effectiveness of the repurchase rate (repo rate) in regulating inflation rate has been a major concern in South Africa. The Bank uses many monetary policy instruments to achieve the inflation rate target of 3% to 6%, but the main instrument used is the repo rate. It is important for an emerging economy such as South Africa to be able to maintain both price stability and attain economic growth. The use of repo rate as the major instrument has not be favourable to some sectors of the economy whereby the main opponent of such approach, Congress of South African Trade Unions (Cosatu), argued that the effect of the inflation targeting through the application of the repo rate has resulted in negative effects on the economic growth.

Literature Review

Data and Methodology

INFt i

Empirical Results

Conclusion and Recommendations