Inflation targeting, economic growth and unemployment rate conundrum amidst energy price pressures and monetary policy in South Africa

Abstract

This study investigated the conundrum of inflation-targeting, economic growth, and unemployment rate amidst energy price pressures and monetary policy in South Africa from 2000 to 2022. Motivated by the persistent criticisms that inflation-targeting harms economic growth and job creation to maintain an inflation rate within the target range, this research sought to understand the broader implications of such a monetary policy framework in the context of fluctuating energy prices, exchange rates, and interest rates. The primary objectives were to assess whether the South African Reserve Bank's (SARB) inflation-targeting framework, formally introduced in 2000, effectively stabilised the inflation rate without adversely impacting economic growth and increasing unemployment rates. Additionally, the research explored the interaction between energy prices, interest rate, exchange rate, and inflation expectations against inflation-targeting, economic growth, and Unemployment rate in a three-model setting. The study utilised three econometric models to achieve its objectives. The Autoregressive Distributed Lag approach was employed for cointegration analysis to determine the long-run relationships among the variables. The Granger causality tests were conducted to identify the direction of causality, while the Impulse Response Functions and Variance Decomposition analyses were used to assess the dynamic interactions and the contribution of each variable to the forecast error variance in the system. The three model results indicated that energy prices had a persistent adverse impact on economic growth and unemployment. The findings revealed that while inflation-targeting successfully contained the inflation rate within the target range, it did not sufficiently promote economic growth and reduce unemployment. The interest rate hikes, though effective in curbing the inflation rate in the short run, had detrimental effects on economic growth and job creation in the long run. The Granger causality tests showed bidirectional causality between interest rate and economic growth. Additionally, IRF results indicated that economic growth reacts negatively towards a shock in interest rates. This implies that persistent increases in interest rates can depress economic growth. The study recommended that the SARB consider adopting a dual mandate monetary policy framework.