Exchange Rate Pass-through Effect On Domestic Prices In South Africa

Understanding the extent to which shocks in the exchange rate affect the domestic price level has particular interest in the formulation of monetary policy especially in the context of inflation targeting countries such as South Africa as it can be used as anchor for inflation expectation.This present study examines the degree of the pass-through effect from ex-change rate shocks to domestic prices(import,producer and consumer price index)in South Africa by using a quarterly data over the period 1980-2016.Additionally,we analyze how the level of the pass-through evolved with regard to the adoption of the inflation targeting regime by utilizing a sub-sample approach.The extent of the exchange rate pass-through(ERPT)is measured through two approaches,which are the single equation regression(OLS method)and Vector Autoregressive(VAR)model.The findings from the single equation approach(Ordinary Least Square method)shows a negative response of domestic prices to exchange rate fluctuations and we evidence that the effect of the pass-through declines along the pricing chain.The same result is also supported by the vector autoregressive approach(VAR)through Impulse Responses Function(IFR)analysis.We find that the effect of the pass-through is higher on import price,medium on producer price and less on consumer price index.Additionally,the results from second stage of the pass-through,which refers to the responses of consumer prices to import and producer price shocks,reveal that the effect of producer prices shocks on consumer price is more im-portant than that of import prices.Finally,in light of shift in the monetary policy regime,the impulse responses function obtained from a sub-sample analysis divided into the period before and after the adoption of inflation targeting framework exhibits a decline in the speed of pass-through to domestic prices,which is especially noticeable in the case of consumer prices.This coincided also with an environment of low and stable inflation following the adoption of inflation targeting framework in South Africa.It is therefore suggested that a more credible monetary policy with emphasis on price stability is essential to minimize the effect of the exchange rate pass-through.The main limitation of this research concerns the dataset used in the study.The use of oil price could have been more significant since it better capture external shocks than the foreign price index used in this current study.Moreover,there is need for further research analyzing the effect of the pass-through at industry or product level also known as disaggre-gate level.