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Navigating Optimal Inflation Targeting in South Africa: A Regime-Switching DSGE Approach

Author

Listed:
  • Junior Maih

  • Ruthira Naraidoo

  • Christian Kakese Tipoy

    (University of KwaZulu-Natal)

Abstract

South Africa’s mineral-driven economy requires adaptive inflation targeting to manage global commodity price volatility. Global commodity price swings challenge the South African Reserve Bank’s (SARB) 4.5% inflation target, adopted in 2000. This paper develops a regime-switching DSGE model to determine the optimal inflation target for South Africa, incorporating heteroskedastic commodity shocks and a regime-dependent Taylor rule. The target varies with policy preferences: output focus raises it, inflation focus lowers it. Optimized policy outperforms historical policy, enhancing inflation control through balanced stabilization, but foreign shocks remain challenging. Excessive interest rate smoothing weakens stabilization, limiting responsiveness. A dynamic targeting approach is essential to enhance resilience against external shocks, offering SARB a framework to adapt policy to South Africa’s commodity-driven conditions.

Suggested Citation

  • Junior Maih & Ruthira Naraidoo & Christian Kakese Tipoy, 2026. "Navigating Optimal Inflation Targeting in South Africa: A Regime-Switching DSGE Approach," ERSA Working Paper Series 207, Economic Research Southern Africa.
    • Handle: RePEc:rza:ersawp:207
    as

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    References listed on IDEAS

    as
    1. Naraidoo, Ruthira & Paez-Farrell, Juan, 2023. "Commodity price shocks, labour market dynamics and monetary policy in small open economies," Journal of Economic Dynamics and Control, Elsevier, vol. 151(C).
    2. Chang, Yoosoon & Maih, Junior & Tan, Fei, 2021. "Origins of monetary policy shifts: A New approach to regime switching in DSGE models," Journal of Economic Dynamics and Control, Elsevier, vol. 133(C).
    3. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    4. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
    5. Dilip M. Nachane, 2016. "Dynamic stochastic general equilibrium (dsge) modelling: Theory and practice," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2016-004, Indira Gandhi Institute of Development Research, Mumbai, India.
    Full references (including those not matched with items on IDEAS)

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    Keywords

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    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
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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