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Monetary policy and inflation in South Africa: A VECM augmented with foreign variables

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  • Annari de Waal

    () (Department of Economics, University of Pretoria)

  • Renee van Eyden

    () (Department of Economics, University of Pretoria)

Abstract

We develop a structural cointegrated vector autoregressive (VAR) model with weakly exogenous foreign variables, suitable for a small open economy like South Africa. This type of model is known as an augmented vector error correction model (VECM), referred to by VECX*. We compile the foreign variables with trade-weighted three-year moving average data for 32 countries, to account for the significant change in trade shares over time. This model is novel for South Africa, in two ways: it is the first VECX* developed to analyse monetary policy in the country and the first model that uses time-varying trade weights for the creation of the foreign series. We find three significant long-run economic relations: the augmented purchasing power parity, the uncovered interest parity and the Fisher parity. These long-run relations are imposed on the VECX* to investigate the effect of a monetary policy shock on inflation. The results suggest the effective functioning of the monetary transmission mechanism in South Africa.

Suggested Citation

  • Annari de Waal & Renee van Eyden, 2012. "Monetary policy and inflation in South Africa: A VECM augmented with foreign variables," Working Papers 201231, University of Pretoria, Department of Economics.
  • Handle: RePEc:pre:wpaper:201231
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    References listed on IDEAS

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    1. repec:vul:omefvu:v:9:y:2018:i:2:id:251 is not listed on IDEAS
    2. Annari De Waal & Reneé Van Eyden & Rangan Gupta, 2015. "Do we need a global VAR model to forecast inflation and output in South Africa?," Applied Economics, Taylor & Francis Journals, vol. 47(25), pages 2649-2670, May.

    More about this item

    Keywords

    South Africa; monetary policy; structural cointegrated vector autoregressive model; augmented VECM; VECX*;

    JEL classification:

    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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