Inflation targeting and inflation performance in South Africa

Formal inflation targeting has been adopted as the monetary policy framework in South Africa since February 2000. Prior to that (since about 1990), the South African Reserve Bank has pursued implicit inflation targeting with no officially announced inflation target. Official inflation targeting frameworks are based on the premise that inflation targeting will deliver improved inflation performance and reduced inflation persistence, as well as contain inflationary expectations. Nevertheless, the international experience seems to suggest that countries that implement official inflation targeting (such as New Zealand, Australia and Canada) are not markedly more successful at maintaining price stability than the countries that do not explicitly target inflation (such as United States, Japan and the European Monetary Union). With regard to South Africa, the record is also ambiguous. During the 1990s, when South Africa had a system of implicit inflation targeting, the South African Reserve Bank was successful in reducing the inflation rate to single-digit figures. However, since the implementation of inflation targeting the CPIX exceeded its 6% upper bound in 31 of the 74 months between February 2002 (the first month that inflation had to be within its target range given a 24 month policy lag) and December 2007. This poses the question whether or not a regime of official inflation targeting is more effective in achieving better inflation performance than a regime with an unofficial (implicit) inflation target, such as the one in South Africa for the period 1990-2000. To answer this question, this paper employs a Vector Error Correction Model (VECM) and a state space model with intervention variables to capture the different monetary policy regimes.