Will the SARB always succeed in fighting inflation with contractionary policy?

Stellenbosch Working Paper Series No. WP15/2011
 
Publication date: 2011
 
Author(s):
Guangling (Dave) Liu (Department of Economics)
 
Abstract:

The conventional view is that a monetary policy shock has both supply-side and demand-side effects, at least in the short run. Barth and Ramey (2001) show that the supply-side effect of a monetary policy shock may be greater than the demand-side effect. We argue that it is crucial for monetary authorities to understand whether an increase in expected future inflation is due to supply shocks or demand shocks before applying contractionary policy to forestall inflation. Using a standard New Keynesian dynamic stochastic general equilibrium model with the cost-channel of monetary transmission, we show that whether the South African Reserve Bank should apply contractionary policy to fight inflation depends critically on the nature of the disturbance. If an increase in expected future inflation is mainly due to supply shocks, the South African Reserve Bank should not apply contractionary policy to fight inflation, as this would lead to a persistent increase in inflation and a greater loss in output.

 
JEL Classification:

E52, E31, E58, E12

Keywords:

Monetary policy, price puzzle, inflation targeting, New Keynesian model

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BER Weekly

1 March 2021
Even with the release of data showing a record high unemployment rate in 2020Q4, it turned out to be a fairly good week for the SA economy. Daily new COVID-19 infections remained well contained, while the second batch of 80 000 J&J vaccines arrived (albeit controversially with the grounded SAA being the carrier). In addition, relative to the October...

Read the full issue