Does the Repurchase Rate Affect Inflation in South Africa? An Empirical Analysis Using an Impulse Response Function

Abstract

The repurchase rate (repo rate) is the most common monetary policy instrument that the South African Reserve Bank (SARB) uses to control inflation and endeavours to keep it within the inflation target band of 3% to 6%. This study examines the effect of the repo rate on inflation rate along with other variables using the Impulse-Response Function (IRF) of a Vector Autoregressive (VAR) technique. This study uses quarterly data spanning over the period 1980Q2 to 2013Q3. The response of a shock in repo rate on inflation rate and vice versa is generally positive. The results show that given one standard deviation shock in the repo rate, inflation rate will initially increase up until the second quarter after which it starts to decline, and increases again in the fifth quarter. The results obtained from the VAR granger causality test show that repo rate leads the gross domestic product (GDP) growth and inflation rate. There is bidirectional causality between inflation and repo rate; and the result is the same, even after structural break was accounted for. The VAR shows no evidence of instability and autocorrelation, hence the results are reliable. The study suggests some policy recommendations.