An investigation of inflationary expectations, money growth, and the vanishing liquidity effect of money on the interest rate in South Africa : analysis and policy implication.
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Date
2001
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Abstract
This thesis measures the extent to which the interest rate falls after an increase in the money supply. Even though the South African Reserve Bank has as a commitment, a goal for the inflation rate to vary between a prescribed band, it still needs to be able to use active monetary policy if economic conditions require intervention. To this end it is of interest to measure the number of quarters for which interest rates remain low after the liquidity of the macro-economy improves. In the monetary literature (for example Melvin (1983)) there are methods that have been used to measure the duration of the decline in the interest rate. These models have not to our knowledge been tested using South African data. We find evidence that the monetary authorities can induce falling interest rates for approximately one quarter using appropriate monetary policy. This result was subjected to testing under alternative assumptions concerning the structure of the error term and found to be robust. This thesis argues for the first time, that there may not be a set pattern to the time path of the interest rate, and inflationary expectations may cause the interest rate to rise, however, this rise is not confined to one uniform adjustment over time, but may occur in separate discrete adjustments. This theoretical innovation and the possibility of an identification problem suggested we estimate another more general model of interest rate determination The second model we estimate is that of Mehra (1985). After a careful analysis of the data to ensure that there are no major statistical problems with the South African data, we find that inflationary expectations result in a higher interest rate especially in times of higher expected inflation. Thus, one benefit of the Reserve Bank's current policy that aims for a band between which the rate of inflation (appropriately defined) must fall, is an improved operation of the transmission mechanism. Therefore, if intervention is required, say, if the economy suffers a severe supply shock, then monetary policy can be effective.
Description
Thesis (M.Com.)-University of Natal, Pietermaritzburg, 2001.
Keywords
Interest rates--South Africa., Fiscal policy--South Africa., Theses--Economics.