Causality links between consumer and producer price inflation in South Africa

This study investigates causal relationships between consumer and producer inflation. In so doing, it makes the following contributions to the literature. First, the methodology allows causality testing within a bivariate system, with other important variables included in the system. Second, the analysis is based on a model chosen out of three other competing models. The models consider the possibility of both symmetric and asymmetric responses to demand and supply shock inflationary situations. This approach differs from the traditional Engle--Granger (EG) approach, which implicitly assumes symmetric adjustment towards equilibrium (Enders and Siklos, 2001). Third, causality testing is conducted within an error correction framework to handle possible inferential biases resulting from invalid asymptotic critical values. The chosen model was used to conduct short- and long-run causality tests within a framework that takes into account differentiated responses to changes in inflation regimes. The following are major findings of this study: There exists dynamic relationship between producer and consumer prices, characterized by unidirectional causality running from producer to consumer inflation. On the issue of asymmetric responses, it is found that consumer inflation reacts differently to positive and negative trends in producer inflation. In other words, consumer price rises faster than it falls.