Our study strongly supports the view that supply side shocks on inflation in SA are best ignored by monetary policy. The analysis infers that raising interest rates in the face of a supply side shock that pushes prices temporarily higher will reduce demand in the economy without affecting inflation in the short term or inflation expected in the short or longer term. We show very clearly that realised inflation has affected inflation expected to a modest degree in South Africa. But the reverse does not hold at all – inflation expected does not affect inflation. Thus in response to supply side shocks, especially those that emanate from net foreign capital flows and the exchange rate, a much better way should be sought to anchor longer term inflationary expectations in SA than raising short term interest rates. It would seem that raising interest rates to fight inflationary expectations or so called second round effects on inflation can impose large costs on the economy in the form of lost output to no useful purpose.
A preliminary draft of our study is available here: Study on Inflation and Inflation Expectations in South Africa
Other recent research on monetary policy:
Lessons from the Global Financial Crisis
A full directory of my research on monetary policy is can be found here: Research Papers – Monetary and Financial Economics