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The author would like to thank staff at the South African Reserve Bank and South African Treasury, seminar participants at the University of Witwatersrand (Johannesburg), the African Department at the IMF, and Jan Gottschalk for helpful comments on an earlier draft.
CPIX is the consumer price index, excluding interest on mortgage bonds.
The Minister of Finance announced the move in his Budget speech on 23 February, 2000. Additional information is contained in the appendix to the Monetary Policy Statement, 6 April 2000, South African Reserve Bank.
The nominal exchange rate is calculated from the impulse response of the real exchange rate and relative prices.
Sims (1980) argues against “incredible identification restrictions” inherent in structural models. For this exercise, in the absence of a prior theory about the relationship between the price variables, a standard nonstructural Cholesky decomposition is used to identify the primitive innovations (see Appendix II for details).
Results from pairwise Granger noncausality tests are inconclusive, finding little evidence of granger causality in either direction.
Athukorala and Menon (1994) point out that pass-through elasticities may be sensitive to how the nominal exchange rate is defined, and since a large share of South Africa’s exports are commodities priced in U.S. dollars, the bilateral rand-U.S. dollar exchange may be more important for transmitting exchange rate shocks to prices.
When I(1) data are cointegrated, a model is misspecified if it is estimated as a differenced VAR because this ignores the levels information from the error-correction process.
The optimal lag length is chosen using Akaike information criterion.
Since the model is estimated in first differences, the impulse responses are for quarterly CPIX inflation. It is necessary to plot the cumulative impulse responses to trace out the impulse response profile for the price level.
Krugman (1987) and Dornbusch (1987) show that under imperfect competition “pricing-to-market” may explain why fluctuations in the exchange rate are not reflected one-for-one in prices. But it would require a structural model to test alternative theories consistent with the low pass-through result.
Distribution costs should be interpreted widely here to include wholesale and retail services that are nontraded.
Consistent with economic theory, the long-run restrictions impose ensure that nominal shocks have no permanent impact on the level of the real exchange rate, but real shocks do.
To identify real supply shocks separately from real demand shocks, additional information is needed, requiring an extension of this framework
The structural shocks are the identified nominal and real shocks. The respective impulse response functions govern how the real exchange rate, nominal exchange rate, and relative prices respond to these shocks.
The results for slope dummies failed to reject the null hypothesis of a unit root.