The Impact of Inflation Targeting on Inflation Volatility in South Africa

Using monthly data from 1960 through to January 2010, this study employs the generalized autoregressive conditional heteroskedastic (GARCH) and GARCH-M (mean) methodologies to estimate the impact of Inflation Targeting (IT) on inflation uncertainty as well as to study whether an increase in inflation causes increased uncertainty and whether a rise in uncertainty causes higher inflation. Moreover the study assesses whether Inflation Targeting has influenced a decline in inflation persistence since its adoption. Due to structural breaks the study uses a shorter series and has found that Inflation Targeting has not been successful in reducing monthly inflation uncertainty. Given that uncertainty has been shown to impose real economic costs, the failure of IT to lower uncertainty as well as inflation persistence in South Africa gives a cautionary lesson for other emerging economies contemplating the adoption of an inflation targeting monetary policy framework.