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Will the Sarb always Succeed in Fighting Inflation with Contractionary Policy?

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  • Guangling (Dave) Liu

Abstract

The conventional view is that a monetary policy shock has both supply-side and demand-side effects, at least in the short run. Barth and Ramey (2001) show that the supply-side effect of a monetary policy shock may be greater than the demand-side effect. We argue that it is crucial for monetary authorities to understand whether an increase in expected future inflation is due to supply shocks or demand shocks before applying contractionary policy to forestall inflation. We estimate a standard New Keynesian dynamic stochastic general equilibrium model with the cost channel of monetary policy for the South African economy to show that whether the South African Reserve Bank should apply contractionary policy to fight inflation depends critically on the nature of the disturbance. If an increase in expected future inflation is mainly due to supply shocks, the South African Reserve Bank should not apply contractionary policy to fight inflation, as this would lead to a persistent increase in inflation and a greater loss in output. Our estimation results also show that, with a moderate level of cost-channel effect and nominal rigidities, a New Keynesian dynamic stochastic general equilibrium model with the cost channel of monetary policy is able to mimic the price puzzle produced by an estimated vector autoregressive model.
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  • Guangling (Dave) Liu, 2013. "Will the Sarb always Succeed in Fighting Inflation with Contractionary Policy?," South African Journal of Economics, Economic Society of South Africa, vol. 81(3), pages 330-345, September.
  • Handle: RePEc:bla:sajeco:v:81:y:2013:i:3:p:330-345
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    File URL: http://hdl.handle.net/10.1111/saje.2013.81.issue-3
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    Cited by:

    1. Stan du Plessis & Ben Smit & Rudi Steinbach, 2014. "Working Paper – WP/14/04- A medium-sized open economy DSGE model of South Africa," Working Papers 6319, South African Reserve Bank.
    2. Stan du Plessis, 2014. "Targeting core inflation in emerging market economies," Working Papers 23/2014, Stellenbosch University, Department of Economics.

    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian

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