Inflation or output targeting? Monetary policy appropriateness in South Africa

Transcription

1 PSL Quarrly Rviw, vol. 69 n. 276 (March 2016), Inflaion or oupu arging? Monary policy approprianss in Souh Africa TEMITOPE LESHORO and UMAKRISHNAN KOLLAMPARAMBIL * Inroducion Th Souh African Rsrv Bank (SARB) implmns is monary policy ojciv of inflaion arging asd on h noion of a Phillips curv (PC). Th dsign and implmnaion of h monary policy hav hus n asd on h ida of a rad-off wn inflaion and oupu growh (du Plssis and Burgr, 2006). Th currn monary policy insrumn of rpo ra sks o arg inflaion y consraining conomic growh and may nirly inappropria if h rad-off prdicd y h PC wr no xisn in Souh Africa. Th currn conrovrsy rgarding h arging of an inflaion ra sms from his uncrainy and fuls h argumn of h Congrss of Souh African Trad Unions (COSATU), ha h SARB should arging mploymn and oupu rahr han inflaion (Epsin, 2005). This is spcially so as Souh Africa has on of h highs lvls of unmploymn in h world and has rcordd lacklusr conomic growh in rcn ims. I is hrfor criical o s h xisnc of Philips curv in Souh Africa. Th ojciv of his papr is o drmin whhr a sal PC xiss in Souh Africa and o ascrain whhr ackward-looking or forward-looking componns drmin inflaion dynamics, using a hyrid Nw Kynsian Phillips Curv (HNKPC) modl. W sima a HNKPC modl for Souh Africa and osrv is snsiiviy joinly o proxy varials, daa frquncy and simaion chniqus. This is rlvan caus various sudis hav shown h * Lshoro: Univrsiy of Wiwarsrand, Johannsurg, and Univrsiy of Souh Africa, Proria, mail: lshola@unisa.ac.za; Kollamparamil: Univrsiy of Wiwarsrand, Johannsurg, mail: uma.kollamparamil@wis.ac.za. This work is licnsd undr a Craiv Commons Ariuion Non-Commrcial No Drivaivs 4.0 Inrnaional Licns. To viw a copy of his licns visi hp://craivcommons.org/licnss/y-nc-nd/4.0/

2 78 PSL Quarrly Rviw snsiiviy of h simas of a PC o various varial masurmns, daa frquncy and conomric chniqus. Alhough prvious sudis hav alrady invsigad h xisnc of a PC in Souh Africa, hr is no consnsus on h conclusions. Morovr, whil many sudis hav considrd dynamic modls, only Malikan, 2013, xplord h HNKPC using an appropria GMM chniqu in h Souh African conx (hough wih a diffrn s of varials han h prsn sudy). Th rs of h papr procds as follows: h dvlopmn of h HNKPC modl and h rlvan liraur for h cas of Souh Africa ar prsnd in h nx scion. Scion 2 xplors h micro foundaions of our HNKPC modl, as wll as h mhodology usd. This is followd y a dscripion of h daa usd, in scion 3, whil h rsuls ar discussd in scion 4. Scion 5 concluds, wih a summary of findings and policy rcommndaions. 1. Brif liraur rviw Alhough an inflaion xpcaions varial was fully ingrad ino simas of h PC in h la 1960s o mid-1970s, criicisms agains using adapiv-xpcaions and rror-larning modls (h so-calld sicky prics approach) as xpcaions-gnraing mchanisms, ld o h raional xpcaions approach and h naural ra of unmploymn hypohsis, dvlopd y Phlps, 1968, and Fridman, Thir connion, conrary o ha of radiional PC modls, was ha hr is no rad-off wn h unmploymn ra and h inflaion ra oh in h shor and h long runs, alhough ohrs (lik Humphry, 1985; King, 2008) livd ha hr could a rad-off in h shor run as a rsul of inflaionary surpriss. Modigliani and Papadmos, 1975, dvlopd h non-acclraing inflaion ra of unmploymn (NAIRU) concp wihin a PC framwork. Th NAIRU dos no imply any commimn o a sal inflaion ra ovr im, and was sn as an improvmn ovr h concp of a naural ra of unmploymn. According o i, whn h

3 Monary policy approprianss in Souh Africa 79 acual unmploymn ra quals h NAIRU, h chang in h inflaion ra will zro (Fuhrr al., 2009). Espcially whn h ra of inflaion in h USA movd low h ra of h NAIRU, h concp of a NAIRU sard ing sn as flawd, wih uncrain simas in h arly o mid-1990s (Mishkin and Esrlla, 1999). According o Fuhrr al., 2009, h uncrain simas would confirm h unrliailiy of h NAIRU in providing assisanc o monary policy makrs. A prolm of uncrainy in h NAIRU is is vry modling, whry h corrc form of modl spcificaion is no known. Th NAIRU cam o sn as a shor-run rahr han a long-run concp of unmploymn. Susqunly, following h xnsion of h nw Kynsian PC modls hrough h inclusion of rms for xpcd inflaion, h focus shifd from wag inflaion o pric inflaion. Rsarchrs concrnd hmslvs wih changs in h mark-up of prics ovr wags. Thrfor, h pric-chang vrsion of modls asd on h PC lar incorporad changs in h ohr inpu prics oo. Th Nw Kynsian Phillips Curv (NKPC), which incorporas xpcd inflaion, was lar criicizd as i was found o inconsisn wih mpirical sudis (Furhr and Moor, 1995; Rudd and Whlan, 2007; Dufour al., 2006; and Hornsin, 2007). Morovr, Kynsian conomics was livd o lack good microfoundaions, caus h Kynsian undrpinnings livd in a complx conomy characrizd y oligopolisic mark srucurs. This is whr firms ar confrond wih mark rigidiis wih horizonal shor-run marginal cos curvs. By conras, Nw Classical conomiss livd in an conomy wih monopolisic firms and consumrs (Lipsy and Scarh, 2011). Ohr criicisms of NKPC modls includ hir inailiy o xplain h dynamic havior of oupu and inflaion, as wll as o xhii nough inflaion and oupu prsisnc dspi h assumpion of pric sickinss (Lndvai, 2004). In h sminal works y Taylor, 1980, and Calvo, 1983, pric sing forward-looking firms wr incorporad ino h NKPC modl, whil Gali and Grlr, 1999, comind h NKPC modl wih

4 80 PSL Quarrly Rviw ackward-looking ffcs, hry dvloping a hyrid NKPC modl (HNKPC). Th assumpion on which NKPC modls wr asd rlas o agns facing high dcision-making coss. In h HNKPC, agns us a simpl rul-of-hum o follow h opimizing agns, wih a onpriod im lag. Thrfor, h HNKPC includs oh pas and acual inflaion rms, as wll as a rm for inflaion xpcaions. Thus, h moivaion of our sudy o us a HNKPC modl as h simaion modl sms no only from h fac ha i is a commonlyusd and widly-accpd modl in mainsram macroconomics, u also caus h HNKPC allows us sing h xisnc of a PC as wll as undrsanding inflaion dynamics r as a forward and/or ackward looking phnomnon. Howvr, mpirical simaions of HNKPC modls hav yildd diffrn rsuls. Som sudis, using GMM simaion chniqus, found a significan forward-looking inflaion rm (Gali and Grlr, 1999), whil ohrs found vidnc of a ackward-looking inflaion (Basarac al., 2011), and y ohrs found mixd componns (Lind, 2005). Similarly, whil som sudis ha usd ECM chniqus found ha inflaion is ackward-looking (Bhanhumnavin, 2002; Hodg, 2002), ohrs found i o forward-looking (Oluusoy and Oyaromad, 2008). In gnral, givn ha diffrn rsuls wr oaind for various counris using diffrn or idnical conomric chniqus, so far no chniqu has n provn as clarly suprior o h ohr, alhough i may also ha diffrn counris hav diffrn inflaion dynamics. In h simas, conflicing rsuls wr oaind concrning h oupu gap varial oo. Whil som sudis found oupu gap o saisically significan and wih a sign consisn wih h horical modl (Loungani and Swagl, 2001; Fddrk and Schaling, 2005; Burgr and Marinkov, 2006; Rudd and Whlan, 2007; and Basarac al., 2011), ohrs found ohrwis (Gali and Grlr, 1999; Rudd and Whlan, 2005). Likwis, diffrn rsuls wr oaind asd on whhr quarrly or annual daa sris wr usd. Many sudis usd quarrly daa (Gali and Grlr, 1999; Lind, 2005; Rudd and Whlan, 2005; Basarac.al, 2011); whil Fuhrr, 1997, and Rors, 2001,

5 Monary policy approprianss in Souh Africa 81 argu ha h HNKPC modl dos no giv h ru inflaion dynamics whn quarrly daa ar usd. Loungani and Swagl, 2001, usd a VAR modl o xamin h inrrlaionship of varials, including oupu gap, o currn inflaion in 53 dvloping counris. Thir rsuls show ha inflaion in African counris xhiis a ackward looking haviour. Basarac al., 2011) simad a hyrid Phillips curv for nin ransiion conomis, using oh a dynamic fixd ffc (DFE) and a Poold Man Group (PMG) approach, whil GMM was usd o s for rousnss. Thy also usd h oupu gap as a proxy for ral marginal cos. Thir rsuls show ha inflaion i.s ackward-looking, as his rm has largr magniud and i is highly saisically significan. Th oupu gap rm was found o posiiv and saisically significan for all h sima modls. Thy hrfor concludd ha h HNKPC modl wih h oupu gap as an xplanaory varial is consisn wih hory in all h counris considrd. Many sudis hav xamind h applicailiy of h PC in Souh Africa, daing as far ack as mor han four dcads, wihou raching a consnsus. Diffrn yps of varials as wll as diffrn chniqus wr usd o drmin h currn inflaion lvl. Whil som of hs sudis hav found vidnc of a sal PC in Souh Africa (Krogh, 1967; Hum, 1971; Hodg, 2002), ohrs, lik Burgr and Marinkov, 2006, and Malikan, 2013, rfu his claim. Th diffrn masurs usd rang from h Gross Domsic Produc (GDP) dflaor (Fddrk and Schaling, 2005) o h Consumr Pric Indx (CPI) and nominal wags (Hodg, 2002; Burgr and Marinkov, 2006). Using PC-asd modls, som sudis considrd whhr inflaion is a ncssary condiion for fasr conomic growh (Nll, 2000, and Burgr and Marinkov, 2006). Hodg, 2002, did no find vidnc of a rad-off wn unmploymn gap and inflaion in Souh Africa, using h radiional Nw Kynsian PC modl wih a singl-quaion rror corrcion modl (ECM). Th sudy, howvr, found a highly significan posiiv rlaionship wn inflaion and oupu growh. This hrfor would imply ha a rad-off wn inflaion and h unmploymn

6 82 PSL Quarrly Rviw gap dos no xis, u hr is a rad-off wn inflaion and oupu growh. In addiion, in h sudy h variaion in inflaion was found o dpndn on is laggd valus, hus inflaion was found o ackward looking. By conras, Fddrk and Schaling, 2005, adopd a vcor rror corrcion modl (VECM) o sima a pur NKPC modl for Souh Africa, using quarrly daa from 1963Q4 o 1998Q2. Thy gnrad a masur of inflaion xpcaions y using adapiv xpcaions, raional xpcaions and h Hodrick-Prsco filr approach, and found Souh African inflaion o forward-looking. In conclusion, h sudis dvlopd so far dmonsra a mix of rsuls and conclusions. Using diffrn conomric chniqus, masurmns and daa frquncy, diffrn conclusions wr rachd on whhr h rad-off implid y h PC xiss, and whhr inflaion is forward-looking or ackward-looking. W hrfor dm i ncssary o s h snsiiviy of our rsuls o various varial masurmns, daa frquncy and simaion chniqus; morovr, w us wo diffrn simaion chniqus, OLS and GMM, unlik all prvious sudis which only usd on. 2. Micro foundaion of HNKPC and mhodology 2.1. HNKPC Th HNKPC is a widly accpd modl in mainsram macroconomics, drivd from h Nw Kynsian modl. I assums ha monopolisically-compiiv firms ar confrond wih shor run pric rigidiy (Gali and Grlr, 1999; Basarac al., 2011). Th aslin modl of h HNKPC rlas inflaion o is lag, xpcaions, and ral marginal coss. Thrfor, h hyrid Phillips curv, which includs an inflaion inria componn, is oaind y comining h aggrga pric indx, h adjusd pric indx and h prics s y

7 Monary policy approprianss in Souh Africa 83 forward-looking and ackward-looking firms. Thus, Gali and Grlr s hyrid Phillips curv modl is: f E ( ) s s, 1) 1 1 whr p is inflaion a im, 1 is laggd inflaion, 1 rprsns inflaion xpcaions and s marginal coss; γ and λ ar h cofficins. Th hyrid PC includs inflaion inria if > 0, i.. h fracion of firms wih ackward-looking pricing havior inroducs inflaion inria. A HNKPC modl has oh inflaion xpcaions and dmand prssur varials. Th dmand prssur varial may masurd y h laour shar (or ral uni laour coss) as a proxy for marginal coss, as in h Gali and Grlr, 1999, modl. Howvr, Agnor and Bayrakar, 2010, argud ha h us of laour shar, spcially in h cas of a dvloping counry, may rsul in unrlial infrncs as a rsul of rrors in h daa. Ths rrors aris from h fac ha hr ar larg numrs of individuals in h laour forc who ar involvd in h informal conomy and whos incoms ar hus no capurd in h daa. Thy consqunly proposd a modl ha rplacs h laour shar wih h oupu gap, Malikan, Thy hus assum ha mpirically s, whr h lar rm is h oupu gap, and h modl coms: 1 f E ( 1) y ky whr β=kλ. In his work w sima a PC modl y incorporaing h HNKPC modl as givn in quaion 2. In addiion, oupu growh will usd in ordr o valida h rsuls of h oupu gap modl, whil also following Lucas, 1973, and Hodg, Anohr rason for h us of oupu growh is ha oupu-gap is livd o riddn wih masurmn rrors rsuling from h inailiy o osrv ponial oupu. Th common lif undr Nw Classical hory is ha hr xiss a ngaiv rlaionship wn inflaion and oupu growh, whry (2)

8 84 PSL Quarrly Rviw a high oupu growh is ndd in ordr o hav low inflaion (Gokal and Hanif, 2004). Howvr, following h Kynsian ida of h PC rad-off, in ordr o rduc inflaion and kp i low, som amoun of oupu growh mus sacrificd, indicaing a posiiv (and significan) rlaionship wn h inflaion ra and oupu growh. Nihr a posiiv or ngaiv oupu gap is idal. This is caus whil a posiiv oupu gap shows ha an conomy opras a an infficin ra y ovrworking is rsourcs, a ngaiv oupu gap qually shows h infficincy of an conomy y undr-uilizing is rsourcs (Jahan and Mahmud, 2013). Funs al., 2007, indica ha a posiiv rlaionship xiss wn inflaion and h oupu gap, caus a posiiv oupu-gap indicas ha inflaionary prssurs ar uilding up. An alrnaiv hory indicas ha h oupu gap is xpcd o ngaivly rlad o inflaion, as an indicaion of h rad-off in h PC (Baini al., 2005). This is caus a posiiv oupu gap is an indicaion ha infficincis incras a an incrasing ra whn oupu is high. Howvr, a ngaiv oupu gap shows ha infficincis in producion incras a a dcrasing ra. This mans ha h inflaion ra will dclin if oupu gap incrass; ha is, incrasd infficincis a an incrasing ra will caus h inflaion ra o fall. Thus, according o h rad-off indicad y h PC, h cofficin of h oupu gap is xpcd o ngaiv. In summary, w osrv ha diffrn horis prdic h rlaionship wn oupu and inflaion o posiiv, ngaiv or non-xisn. Nvrhlss, h monary policy in Souh Africa is asd on h lif of h rad-off wn inflaion and oupu growh and hnc w will s h null hypohsis ha h PC xiss in Souh Africa. Thus, h xpcd sign in h HNKPC modl is ngaiv for oupu gap and posiiv for oupu growh. 2.2 Esimaion mhods All varials wr firsly sd for saionariy using h Augmnd Dicky-Fullr (ADF), Phillips-Prron (PP) and h Dicky-

9 Monary policy approprianss in Souh Africa 85 Fullr GLS (DF-GLS) drndd 1 ss. Thn, w xamind h possil long-run rlaionship wn hm. Th saionariy s rsuls ar prsnd in h Appndix (Tals A1 and A2). For h annual sris, only h inflaion ra and xpcd inflaion, masurd y h HP-filr, wr found o ingrad of ordr on, I(1). Oupu growh and h oupu gap wr found o ingrad of ordr zro, I(0). Th varials in quarrly sris wr sd for saionariy and wr all found o saionary a lvls. Thus, hr was no nd o s for co-ingraion among h varials of h quarrly daa sris. W could no mak us of h sandard Johansn co-ingraion s caus of h inclusion of a ackward-looking componn in h HNKPC modl. For h sam rason, w could no us h Vcor Error Corrcion Modl (VECM) mhod. Th auorgrssiv disriud lag (ARDL) could also no adopd as an approach o co-ingraion du o h prolm of having ackward looking inflaion as an xplanaory varial. Hnc, h s alrnaiv approach o co-ingraion usd in his sudy is h Fully-Modifid Ordinary Las Squars (FMOLS), popularizd y Phillips and Hansn, 1990) o formally s h prsnc of possil long-run co-ingraing rlaionships among h varials. Som of h advanags of using his chniqu ar ha h FMOLS simaor mploys a smi-paramric corrcion, which liminas h ias rsuling from ndogniy. This chniqu prforms r in small sampls and also incorporas h corrcions for possil srial corrlaion. FMOLS dos no dpnd on lag lngh, h -raios oaind from FMOLS ar asympoically normally disriud and h rsuls ar rous. 2 Th coingraing quaion is shown in quaion (3) low (whr μ is h rror rm). 1 Sinc his sudy includs wo dummy varials, h aov ss wr usd insad of h Zivo-Andrws s of uni roo, which is usd in h cas of unknown srucural raks. 2 For mor dails on FMOLS, s Borland and Ouliaris, 1994.

10 86 PSL Quarrly Rviw y D _ IT D _ FC f y IT FC (3) Ordinary Las Squars (OLS) simas ar h Bs Linar Uniasd simas (BLUE) in hir class of linar simas. OLS howvr, assums Cov(u i, X i) = 0, which may violad in h prsnc of rvrs causaliy wn varials lik inflaion and oupu growh, lading o a prolm of ndogniy. W hrfor follow up h OLS simaion y using GMM simaion. In mos conomic modls, on or mor xplanaory varials ar found o ndognous; hnc, h wo main rasons for h applicaion of a GMM chniqu in his sudy ar o corrc for auocorrlaion of h rsiduals in a sandard OLS simaion and o addrss h possil prolm of ndogniy. 3. Daa 3.1. Modl spcificaion and daa W xplor h xisnc of h PC in Souh Africa using quaion (2). Rousnss will sd y using diffrn varial proxis, simaion chniqus and daa frquncy. Th modls simad ar: Including oupu growh: y Including h oupu gap: y f f y y gap( ) D _ IT D _ IT IT IT FC FC D _ FC D _ FC (4) (5) whr is h lag of inflaion, which capurs h ackward-looking componn of inflaion xpcaions. Inflaion xpcaions ar furhr

11 Inflaion ra and oupu growh (%) Oupu Gap Monary policy approprianss in Souh Africa 87 masurd in wo ohr ways: a dmand-sid varial ha capurs oupu growh, y (xpcd o hav a posiiv rlaion o inflaion undr PC), and on for h oupu gap, y gap (xpcd o hav an invrs rlaion o inflaion undr PC). HNKPC modls ar usually simad wihou a consan rm, as in quaions (4) and (5). For priod considrd, h dmand-sid varials, oupu growh and oupu gap, ar prsnd along wih h inflaion ra in figur 1. Th varials inflaion ra and oupu gap appar o mov closly oghr. Th co-movmn of oupu growh and inflaion is visually lss vidn. Figur 1 Annual inflaion, oupu growh and h oupu gap Inflaion ra Oupu growh Oupu Gap Sourc: Inrnaional Monary Fund, Inrnaional Financial Saisics (IMF/IFS). Two im dummy varials ar inroducd, o accoun for wo major vns during h priod of h sudy, i.. h adopion of inflaion arging as h officially monary policy of h Souh African

12 88 PSL Quarrly Rviw Rsrv Bank in 2000 (D_IT), and h gloal financial crisis in h priod (D_FC). Thus, h wo dummis ar dfind as follows: 1 IT from 2000 onwards D_IT = { 0 ohrrwis 1 for 2008 o 2011 financial crisis D_FC = { 0 ohrwis Annual daa from 1980 o 2012 and quarrly daa from 1980Q1 o 2013Q3 and sparaly for 2000Q3 o 2013Q2 wr usd, caus daa from inflaion survys ar only availal from 2000Q3 o 2013Q2. Indd, w us hr diffrn ways of oaining inflaion xpcaions in Souh Africa. Ths ar: h Hodrick-Prsco filr, ARIMA simaion of h im sris, and daa from survys carrid ou y y h Burau of Economic Rsarch (BER) and h Rurs Inflaion Expcaions (RIE). Daa on inflaion xpcaions from h BER survy ar availal quarrly saring from h firs quarr of 2000, whil h daa from RIE ar availal monhly from Dcmr 1999 (Ehlrs and Sinach, 2007). Th survy on inflaion xpcaions conducd y BER is pulishd on half of h SARB. This survy is asd on four groups of rspondns: housholds, h usinss scor, h financial scor and h rad union scor. Alhough hs survys ar usful, hy ar howvr pron o iass. Such iass includ forcasrs no rvaling hir ru forcass, lack of sufficin incnivs ha will allow hm mak us of h availal rsourcs whn answring h survy qusionnair and h lack of aaching wighs o rsponss according o h numr of rspondns and who hy ar (Woodward, 1992). Th hr diffrn masurs of inflaion xpcaions ar prsnd in figur 2, using quarrly daa from 2003Q3 o 2013Q2. As shown, h inflaion xpcaions from survys daa show mor variailiy han inflaion xpcaions asd on h Hodrick-Prsco filr and h ARIMA modl. Howvr, w will considr all masurs as a rousnss chck. (6)

13 2000Q3 2001Q2 2002Q1 2002Q4 2003Q3 2004Q2 2005Q1 2005Q4 2006Q3 2007Q2 2008Q1 2008Q4 2009Q3 2010Q2 2011Q1 2011Q4 2012Q3 2013Q2 Expcd inflaion using Hodrick-Prsco and ARIMA (%) Expcd using survy (%) Monary policy approprianss in Souh Africa 89 Whil hr diffrn masurs of inflaion xpcaions wr sparaly includd in h rgrssions alongsid h oupu gap and oupu growh using quarrly daa, only h Hodrick-Prsco filr masur of inflaion xpcaions was usd o sima annual daa. Thus, h modls o simad ar as follows. Annual sris: Modl 1: ( HP) y f y gap D _ IT IT Figur 2 Thr masurs of inflaionary xpcaions (2000Q3 o 2013Q2) FC D _ FC (7) 2 1,8 1,6 INFL_HP INFL_ARIMA SURVEY ,4 1, ,8 0,6 4 0,4 0, Sourc: Inrnaional Monary Fund, Inrnaional Financial Saisics (IMF/IFS). Whil hr diffrn masurs of inflaion xpcaions wr sparaly includd in h rgrssions alongsid h oupu gap and oupu growh using quarrly daa, only h Hodrick-Prsco filr

14 90 PSL Quarrly Rviw masur of inflaion xpcaions was usd o sima annual daa. Thus, h modls o simad ar as follows. Annual sris: Modl 2: ( HP) y D _ IT D _ FC f y IT FC (8) Quarrly sris: Modl 3: ( survy) y Modl 4: Modl 5: Modl 6: Modl 7: Modl 8: f f y y gap D _ IT ( survy) y D _ IT ( HP) y f f y gap y IT IT IT D _ IT IT FC FC FC D _ FC D _ FC D _ FC ( HP) y D _ IT D _ FC ( ARIMA ) y f f y y gap IT FC D _ IT ( ARIMA ) y D _ IT IT FC FC D _ FC D _ FC (9) (10) (11) (12) (13) (14) Tal 1 provids h varials dfiniions and frquncy. All varials wr sourcd from h daaas of h Inrnaional Monary Fund, Inrnaional Financial Saisics (IMF/IFS).

15 Monary policy approprianss in Souh Africa 91 4 Empirical rsuls 4.1. Co-ingraion and OLS rsuls Th quarrly daa sris ar no sd for co-ingraion caus hy wr all saionary a lvls (al A2 in appndix). Sinc h varials for h annual sris wr ingrad of diffrn ordrs (al A1 in appndix), co-ingraion among h varials wr sd using h Fully-Modifid Ordinary Las Squars (FMOLS) approach o coingraion. Th co-ingraion ss rsuls showd ha hr is a saionary linar cominaion of hs non-saionary varials (al 2), indicaing a long-run rlaionship. Alhough h dmand sid varial, h oupu-gap, has h xpcd sign, i is no saisically significan. Oupu growh is also no saisically significan. Whil inflaion dynamics sm o oh forward and ackward looking, a high lvls of significanc, h inflaion xpcaions varial appars o hav a highr magniud, indicaing a mor pronouncdly forward looking havior in oh modls in h long-run. Having salishd co-ingraion for h annual sris, w run co-ingraing rgrssion modls using OLS (modls 1 and 2), rpord in al 3. Th rsuls show ha hr is no rad-off wn h dmand-sid varials and inflaion, as would suggsd y h PC. Oupu gap is no saisically significan in any of h modls, xcp modl 3 (whr h posiiv sign of h cofficin indicas no rad-off anyways). Thus, on h asis of an OLS analysis w would conclud ha hr is no vidnc of a PC in Souh Africa, irrspciv of h dmand-sid masurs or daa frquncy usd. Th sam findings wr oaind y Hodg, 2002, who usd an rror corrcion mchanism o sima h radiional PC for Souh Africa.

16 92 PSL Quarrly Rviw Tal 1 Varials and dfiniions for h Hyrid NKPC modl Varial Varial dfiniion Frquncy Inflaion ra, drivd from h 1980 o 2012; Inflaion consumr pric indx a Q1 o 2013Q3 prics Laggd inflaion D_IT D_FC Lag of h inflaion ra Dummy varial capuring h adopion of inflaion arging in yar 2000 Dummy varial, capuring h priod of gloal financial crisis, 2008 o Masurs of Expcd inflaion varials, i) Survy, (survy) i) Burau of Economic Rsarch Survy daa 1980 o 2012; 1980Q1 o 2013Q o 2012; 1980Q1 o 2013Q o 2012; 1980Q1 o 2013Q3 i) 2000Q3 o 2013Q2 ii) Hodrick Prsco (HP) filr, iii) ARIMA, (HP) (ARIMA) Dmand sid varials i) Oupu gap y gap ii) Hodrick Prsco (HP) filr approach (Fddrk and Schaling, 2005) iii) ARIMA is oaind using h forcas approach i) diffrnc wn acual and ponial oupu, using h Hodrick Prsco (HP) rnd ii) growh ra of ral GDP: ii) Oupu y growh y y 1 y 1 ii) 1980 o 2012; 1980Q1 o 2013Q3 ii) 1980Q1 o 2013Q3 i) 1980 o 2012; 1980Q1 o 2013Q3 ii) 1980 o 2012; 1980Q1 o 2013Q3

17 Monary policy approprianss in Souh Africa 93 Tal 2 Rsuls of FMOLS co-ingraion ss, dpndn varial: inflaion ra (annual daa: 1980 o 2012) (HP) y Modl 1 Modl *** (0.10) 0.64*** (0.10) 0.31*** (0.12) 0.71*** (0.13) (0.09) y gap ( ) Phillips-Ouliaris s Tau sa: -4.59*** Tau sa: -4.41** Hansn Insailiy s Lc sa: 1.97*** Lc sa: 1.64** Nos: in all als *** dnos saisical significanc a 1%, ** a 5%, and * a 10%, rspcivly; sandard rrors ar rpord in parnhss. Th modl, simad in a non-diffrncd form, includs an inrcp wih no addiional drminisic rnd. Null hypohsis is ha sris ar no co-ingrad. Alhough inflaion dynamics in Souh Africa sm o rlaivly mor forward-looking, h rsuls also shows a mix in rms of h significanc of oh componns. Forward-looking componns ar usually significan, xcp in modls 3 and 4 whr h survy masur of inflaion xpcaions is usd. Th ackward-looking varial is saisically significan in mos quarrly daa modls. Th rsuls raffirm h FMOLS findings ha h forward-looking componn has largr magniuds compard o h ackward-looking inflaion componn, xcp whn using survy masurs of inflaion xpcaions. This shows ha, according o oh FMOLS and OLS rsuls, conomic agns ar oh raional and adapiv in prdicing inflaion, alhough h snsiiviy of h HNKPC modl o diffrn masurs of inflaion xpcaions is vidn. 3 3 All modls passd h usual ary of diagnosic ss, as shown in al A3 in appndix.

18 Adj.-R2 DW-d sa D_FC D_IT y gap( ) y ( ARIMA) (survy) (HP ) ( ) (0.82) 0.92 (1.36) (0.18) 0.74*** (0.19) 0.50 (0.96) 0.68 (1.33) (0.17) 0.14 (0.20) 0.89*** (0.22) Annual daa: co-ingrad rgrssion Modl 1 Modl *** ( ) 0.63** (0.30) (0.28) * (0.06) 0.16 (0.16) Modl (0.40) (0.32) (0.22) 0.09 (0.06) 0.37** (0.15) Modl ( ) 0.14 (0.15) (0.27) *** (0.08) 0.74*** (0.09) Modl (0.17) (0.28) (0.09) 0.24*** (0.09) 0.78*** (0.09) Modl 6 Quarrly daa: saionary sris Tal 3 OLS simaion rsuls, dpndn varial: inflaion ra ( ) 0.07 (0.17) (0.29) *** (0.08) 0.41*** (0.08) Modl (0.18) (0.29) *** (0.09) (0.10) 0.39*** (0.08) Modl 8 94 PSL Quarrly Rviw

19 Monary Policy approprianss in Souh Africa Gnralizd Mhod of Momns (GMM) rsuls Esalishing valid and rlial rsuls rquirs ha rousnss chcks carrid ou. This can don y ihr using h sam chniqu u changing h varials, or using a diffrn chniqu. In his scion w hrfor us a GMM chniqu o furhr affirm h OLS rsuls aov. Valid insrumns for simaing h HNKPC modl may no asily idnifid, u sudis, Gali and Glr, 1999; Malikan, 2013) hav shown ha h insrumns ha ar usd mus laggd. This is caus h insrumns hav o uncorrlad wih h rsidual in h HNKPC modl. Th insrumns wr chosn following Gali and Grlr, 1999, Gali al., 2005, and Nason and Smih, Rsuls ar prsnd in al 5 low, whil diagnosic ss for h validiy of h insrumns, as wll as for normaliy, ndogniy and sailiy of h modl, ar shown in al A4 in appndix. Th GMM chniqu producs rsuls ha lad us o assr ha h PC curv dos no xis in Souh Africa (al 4). In modl 1, h oupu growh varial dos no hav h sign prdicd y h PC modl: w find a saisically significan invrs rlaionship wih inflaion ras, insad of h xpcd posiiv rlaionship. In modls 2 and 4, h oupu gap has a saisically significan posiiv sign, hus rfuing again h hypohsis of a PC. In h ohr modls (3, 5, 6, 7 and 8), oupu growh and h oupu gap do no significanly affc inflaion. Thrfor, his sudy concluds ha h Souh African conomy dos no xhii a PC during h priod of sudy, asd on ihr h rlaionship of oupu gap or of oupu growh wih inflaion. Ths findings ar, on on hand, conrary o h rsuls of Hodg, 2002, who found ha hr is a shor-run rad-off wn inflaion and oupu growh. On h ohr hand, our vidnc suppors his findings of no rad-off whn h simad h rlaionship wn inflaion and h unmploymn gap. Th GMM rsuls furhr show mixd vidnc on whhr inflaion is forward-looking or ackward-looking in Souh Africa. Alhough oh componns ar saisically significan in many

20 96 PSL Quarrly Rviw insancs, h magniuds of h cofficins of h forward-looking varials ar highr han hos of h inflaion lag varial, whn h HP filr and ARIMA ar akn as h proxis for inflaion xpcaions. This finding is in lin wih h sudy y Fddrk and Schaling, 2005, who usd VECM chniqu, and also found ha inflaion in Souh Africa is forward-looking. Thus, on may say ha alhough conomic agns in Souh Africa ar oh raional as wll as adapiv in naur, hy sm o mor raional han adapiv. Furhrmor, h rsuls show ha HP-filr and ARIMA ar r masurs of inflaion xpcaions han survy. Th cofficins of HP-filr and ARIMA ar no only conomically significan, having h xpcd signs; hy ar also highly saisically significan. Apar from hs, hy hav largr valus compard o h valu of h inflaion lag. Alhough survy was xpcd o h s masur of inflaion xpcaions, h rsuls show ohrwis. This may ariud o h fac ha whil HP-filr and ARIMA ar dircly oaind from h inflaion ra sris, survy daa may hav limiaions. Alhough h survy is asd on four groups of rspondns (namly h housholds, h usinss scor, h financial scor and h rad union scor) hy ar pron o iass. Such iass includ forcasrs no rvaling hir ru forcass, insufficin incnivs ha will allow hm making us of h availal rsourcs whn answring h survy qusionnair, and h lack of aaching wighs o rsponss according o h numr of rspondns and who hy ar, (Woodward, 1992; Thomas, 1999). Ths rsuls show ha h HNKPC modl is no snsiiv o daa frquncy as no on modl giv r rsuls of inflaion dynamics in Souh Africa, ovr h priods of sudy. This sudy hrfor could no affirm h findings of Fuhrr, 1997, and Rors, 2001, who argud ha h HNKPC modl dos no giv h ru inflaion dynamics whn using quarrly daa. Also, wn h wo dummy varials usd, only ha capuring inflaion arging, D_IT, is saisically significan in som of h modls.

21 -0.54** (0.22) 0.13 (0.41) 0.07 (0.16) Modl *** (0.11) (0.10) Modl (0.17) 0.20 (0.25) (0.17) 0.53*** (0.09) Quarrly daa: 2000Q3 2013Q2 Modl 5 Modl 6 Modl ** 0.28** 0.45*** (0.12) (0.14) (0.08) 0.66*** 0.70*** (0.14) (0.15) 0.52*** (0.19) Modl *** (0.19) ygap( ) * ** ( ) ( ) ( ) ( ) 1.34* ** -0.73* IT (0.71) (0.91) (1.13) (0.49) (0.43) (0.34) (0.46) (1.23) FC (1.26) (1.44) (0.69) (1.00) (1.48) (1.39) (1.00) (3.67) R Adj.-R Nos: insrumns for GDP growh includ a consan rm, hr lags of currn inflaion, xpcd inflaion (HP-filr, survy and ARIMA), inflaion lag and wo lags of oupu growh; insrumns for GDP gap: consan rm, wo lags of currn inflaion, xpcd inflaion (HP-filr, survy and ARIMA), inflaion lag and oupu gap. y f (ARIMA) f (survy) f (HP) Annual daa: Modl 1 Modl *** (0.12) (0.12) 1.03*** 0.62*** (0.14) (0.13) Tal 4 GMM inflaion simaion rsuls Monary Policy approprianss in Souh Africa 97

22 98 PSL Quarrly Rviw 5. Conclusions This sudy xplors h snsiiviy of h HNKPC modl o various varial masurmns, daa frquncy and simaion chniqus in invsigaing h xisnc of an oupu-asd HNKPC in Souh Africa. Th moivaion for h sudy was o inform monary policy how oupu affcs inflaion in Souh Africa. Th rsuls oaind confirmd ha a sal PC dos no xis in Souh Africa. This was dmonsrad hrough various masurs of dmand-sid varials. Ths findings ar rous across simaion mhodologis, as wll as diffrn masurmns of inflaion xpcaions and daa frquncy. Th implicaion of h finding is farraching in h conx of h currn conrovrsy in Souh Africa rgarding whhr h SARB should arging inflaion or growh. Our findings suppor h argumn ha, givn h lack of a rad-off wn oupu growh and inflaion, growh arging maks mor sns han inflaion arging. Whil our findings indica ha conomic agns in Souh Africa ar oh raional and adapiv in prdicing inflaion, h rsuls clarly indica h dominanc of forward looking varials ovr h ackward looking ons in drmining inflaion. This is conrary o h findings of Malikan, 2012, ha ackward-looking procsss drmin inflaion in Souh Africa. Th conclusions, howvr, ar sn o snsiiv o h masur of inflaion xpcaions, wih h survy masur of inflaion xpcaions no yilding maningful indicaions. W ariu his o h limiaions of h survy mhodology as our rsuls wih wo ohr masurs of inflaion xpcaions ar consisn across mhodologis and daa frquncis. Whil our analysis indicas no rad-off wn inflaion and oupu growh in Souh Africa, lading o h rcommndaion ha monary auhoriis giv mor anion o incrasing oupu wihou worrying aou h inflaion ffc of oupu growh, i is impraiv o also chck for consisn rsuls wih diffrn modl spcificaions y including monary, fiscal and srucural varials. This has n

23 Monary Policy approprianss in Souh Africa 99 yond h scop of h currn analysis u forms h agnda for furhr rsarch in kping wih h viw of Grun al., 1999, ha, for h riniy of nfis 4 of PC o hold, i mus augmnd o allow for h ffcs of addiional supply sid, monary and fiscal varials. Appndix Tal A1 Saionariy ss: annual daa ( ) (HP) y y gap LEVELS FIRST DIFFERENCE ADF PP DF-GLS ADF PP DF-GLS Dcision *** ** I(1) *** *** *** I(1) *** *** *** NA NA NA I(0) ** * *** NA NA NA I(0) 4 Sigliz, 1997, highlighd h hr nfis of PC as; xplaining h drminans of inflaion, for policy purpos and for inflaion forcasing.

24 100 PSL Quarrly Rviw Tal A2 Saionariy ss: quarrly daa (2000Q 2013Q2; 1980Q 2013Q3) π (a) π () LEVELS ADF PP DF-GLS Dcision *** *** *** I(0) *** *** *** π () (HP) * ** I(0) π (a) (Survy) ** *** I(0) π () (ARIMA) *** *** *** I(0) y (a) y () ** *** * *** ** * ygap (a) ygap () ** *** ** *** ** *** I(0) Nos: h rows dnod y (a) rpor h rsuls for h 2000Q3 2013Q2 sris, () hos for h 1980Q1 2013Q3 sris. I(0) Tal A3 Rsuls of h diagnosic ss of h OLS modls Normaliy Ts (Jarqu-Bra) Srial Corrlaion LM Ts (Brusch- Godfry F-saisic) Hroskdasici y Ts (Brusch- Pagan-Godfry F-saisic) Ramsy RESET Ts (F-saisic) Modl 1 Modl 2 Modl 3 Modl 4 Modl 5 Modl 6 Modl 7 Modl (0.27) (0.43) (0.15) (0.56) (0.06) (0.16) (0.47) (0.73) 0.61 (0.55) 0.34 (0.91) 0.04 (0.85) 0.15 (0.86) 0.84 (0.55) (0.95) 0.31 (0.73) 0.42 (0.90) 2.22 (0.15) 0.31 (0.73) 0.64 (0.70) 0.72 (0.40) 0.26 (0.77) 0.13 (0.99) 0.29 (0.59) 0.79 (0.46) 1.20 (0.31) 0.58 (0.45) 1.77 (1.17) 0.21 (0.97) 1.83 (1.18) 0.41 (0.66) 0.54 (0.80) 2.21 (0.14) Nos: figurs in parnhss rpor p-valus.

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