Inflation Or Output Targeting? Monetary Policy Appropriateness In South Africa

The design and implementation of the monetary policy in South Africa has been based on the idea of a trade-off between inflation and output growth. However, there is no consensus among empirical investigations on the existence of Phillips curve in the present times. The significant contribution of this study is to estimate the Hybrid New Keynesian Phillips Curve model with a view to determine whether Phillips curve exists and ascertain whether the backward-looking or forward-looking components drive inflation dynamics in South Africa using OLS and GMM estimation techniques. The results obtained confirmed that the Phillips curve does not exist in South Africa using various measures of demand-side variable. These findings are robust across estimation methodologies as well as different measurements of inflation expectations and data frequency. Our findings therefore support the argument that the monetary policy ought to aim at targeting growth rather than inflation. While our findings indicate that economic agents in South Africa are both rational and adaptive in predicting inflation, the results clearly indicate the dominance of forward looking variables over the backward looking ones in driving inflation.