Exchange Rate Pass-through and Monetary Policy in South Africa

Understanding how import prices adjust to exchange rates helps anticipate inflation effects and monetary policy responses. This paper examines exchange rate passthrough to the monthly import price index in South Africa during 1980-2009. A methodological innovation allows various short-run pass-through estimates to be calculated simply without recourse to a full structural model, yet without neglecting the long-run relationships between prices or the effects of previous import price changes, and controlling for domestic as well as foreign costs. Pass-through is incomplete at about 50 percent within a year and 30 percent in six months, averaging over the sample. Johansen analysis of a cointegrated system using impulse response functions largely supports these short-run results, but as it includes feedback effects, implies lower pass-through for exogenous exchange rate shocks. Equilibrium pass-through, ignoring feedback effects, is around 75 percent. Shifts in pass-through with trade and capital account liberalisation in the 1990s are explored. There is evidence of slower pass-through under inflation targeting when account is taken of temporary shifts to foreign currency invoicing or increased hedging after large exchange rate shocks in the period. Further, pass-through is found to decline with recent exchange rate volatility and there is evidence for asymmetry, with greater pass-though occurring for small appreciations.