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Research Proposal for a Doctor of Philosophy (PhD) in Economics in the
Faculty of Commerce Law and Management at the University of the Witwatersrand
Name of Applicant:
Kenneth Creamer
Supervisor:
Dr Greg Farrell
School:
School of Economic and Business Sciences (SEBS)
Title:
Price Setting and Monetary Policy in South Africa
Date:
31 October 2006
1
Research Proposal for a Doctor of Philosophy (PhD) in Economics in the Faculty of
Commerce Law and Management at the University of the Witwatersrand
Name of Applicant:
Student Number:
Staff Number:
Kenneth Creamer
8804489R
00300462
Intended Degree:
Department:
School:
Doctor of Philosophy in Economics (Part Time)
Economics
School of Economic and Business Sciences (SEBS)
Supervisor:
Dr Greg Farrell, SEBS University of the Witwatersrand
Assisted by:
Dr Peter Sinclair, Professor of Economics at the
University of Birmingham,
Dr Stephen Gelb, SEBS, University of the
Witwatersrand
Dr Neil Rankin, SEBS, University of the Witwatersrand
Dr Chris Malikane, SEBS, University of the
Witwatersrand
Date:
31 October 2006
Signed by:
______________________________
Kenneth Creamer (Applicant)
_______________________________
Dr Greg Farrell (Supervisor)
________________________________
Professor Harry Zarenda (Acting Head of School)
[The process for the submission of this proposal has been as follows. The
development of the proposal has been guided through a number of meetings with Dr
Greg Farrell as well as input from those assisting in advising on the research. The
proposal was discussed at an informal SEBS seminar on 7 July, 2006 and at a
formal presentation to SEBS delivered on 31 August, 2006. Comments and
criticisms made through these processes have assisted in shaping this proposal in
preparation for consideration by the Panel established to advise the Faculty of
Commerce Law and Management’s Higher Degrees Committee.]
2
Title:
Price Setting and Monetary Policy in South Africa
Table of Contents:
Abstract
1.
Introduction
a. Overview
b. Macroeconomic context
c. Literature Review
2.
Survey of the price setting conduct of South African firms
a. Overview
b. Sample selection
c. Substance of the Survey
d. Survey Findings
3.
A micro-data analysis of price setting in the South African economy
a. Overview
b. Analysis of frequency of price changes
c. Analysis of size of price changes
4.
Modeling the implications of pricing conduct for monetary policy in
South Africa
a. Overview
b. Modeling the implications of pricing behaviour
c. Conclusion
5.
Bibliography
3
Abstract
This research proposal, firstly, seeks to test the hypothesis that there are significant
price rigidities in the South African economy, and, secondly, seeks formally to
model how the prevalence of such price rigidities would impact on the optimal
conduct of monetary policy. To test for price rigidities, use will be made both of a
survey of the pricing conduct of South African firms and of a micro-data analysis of
South Africa’s official consumer price dataset. In testing for price rigidities, Blinder
et al’s (1998) finding for the US economy that 78 percent of the GDP is priced
quarterly or less frequently, and the finding of the European Central Bank’s
Inflation Persistence Network (Altissimo et al 2006) that the average duration of
consumer prices is 4 to 5 quarters, will be treated as benchmarks in assessing the
comparative significance of the degree of price rigidity in the South African
economy. Furthermore, a number of important descriptive features of price setting
conduct in the South Africa economy will be revealed through the survey and the
data study, including inter alia the degree of upward and downward symmetry in
price setting, inter-sectoral comparisons of the frequency, degree and seasonality of
price adjustments, and the rating of the applicability of various microeconomic
theories of price setting conduct. To model the implications of the findings on price
rigidities for the optimal conduct of monetary policy, a framework with a New
Keynesian Phillips curve will be developed for South Africa. This will enable a
micro-founded macroeconomic analysis of the co-movement of real and nominal
variables, including a study of the optimal conduct of monetary policy in the
presence of cost push shocks, and will indicate the implication of interest rate setting
for output and inflation and the nominal and real policy rates.
JEL Classifications: E31, E521
Keywords: Price setting, inflation data, real effects of monetary policy
1
E31 Price level, inflation, deflation; E52 Monetary Policy (Targets, Instruments and Effects)
4
Section 1:
1.a
Introduction
Overview
It is proposed that the research into price setting and monetary policy in South Africa be
structured into three distinct but inter-related sections, as follows.
Firstly, an analysis of the results of a survey of price setting behaviour in the South
African economy. This will include:
- A discussion and outline of the survey methodology and the applicability of such
methodology to studies of price setting behaviour.
- An analysis of the results of the survey, including an outline of price setting conduct at
an aggregate level and at various sectoral levels in South Africa.
- An evaluation of the applicability of various theories of price stickiness in the South
African context.
- A detailed analysis of survey results, including an ordered probit sectoral analysis of the
results and a comparison of South Africa’s results with price-setting surveys conduct in
other countries.
Secondly, a micro-data analysis of a recent sample of South African price data as a basis
for analysing price setting behaviour in the South African economy. This will include:
- The use of unit level CPI micro-data to analyse inter alia the frequency of price changes,
the size of price changes, and the seasonality of price changes at an aggregate and
sectoral level.
- An analysis of whether price setting in South Africa is state dependent or time
dependent, that is, an analysis of the extent to which price setting responds inter alia to
interest rate, exchange rates and general pricing developments, versus the extent to which
price setting takes place regularly after particular time intervals.
Thirdly, an analysis of how price setting behaviour is relevant to the conduct of monetary
policy in South African. This will include:
- A review of recent studies which show how monetary policy shocks are modeled to
result in changes in output and other real variables if there is a prevalence of nominal
rigidities, and a discussion on the applicability these findings to South Africa.
- A formal analysis in a New Keynesian framework of how price setting behaviour can be
shown to impact upon the optimal conduct of monetary policy in response to various cost
push shocks, such as, an oil price shock, an exchange rate shock and a wages shock.
- A key question being whether in the context of price rigidities a response to cost shocks
would be better served by a moderate interest rate response rather than a sharp interest
rate increase which would tend to result in greater retardation of output and employment
growth.
- A conclusion which integrates the theoretical and empirical results into a discussion
about the optimal conduct of monetary policy in South Africa.
5
1.b
Macro-economic context
The proposed study of price setting behaviour and the implications for the conduct of
monetary policy in South Africa takes place against a backdrop of significant moderation
in levels of inflation2, yet the inflation rate has continued to be volatile mainly due to
exchange rate volatility. As Fig.1 indicates, average year on year CPI inflation in the
period 1990-1994 was 12,45%, 1995-1999 7,36% and 2000-2004 5,51%.
Notwithstanding the higher rate of inflation in recent months, the average CPI inflation
rate since the beginning of 2005 to the mid-2006 remains below 4% per annum.
18
16
14
12
10
8
6
4
2
0
2004/09
2002/11
2001/01
1999/03
1997/05
1995/07
1993/09
1991/11
CPI 1990 - 2006
1990/01
%YoY
Figure 1. CPI 1990 - 2006
Inflation volatility, measured by the standard deviation of the CPI indicates a mixed
picture as during the period 1990-1994 the standard deviation was 2,87%, decreasing to
2,24% from 1995-1999, and rising again to 3,43% from 2000-2004, see Table 1. Since
2005 inflation has continue to be moderate and stable with a standard deviation of only
0,49%.
2
It is submitted that a study of price setting behaviour during a period of relatively moderate inflation will
enable a more nuanced study of such conduct, that is, one that is not overwhelmed by the impact on pricing
of any particular macro-economic imbalance, such as a collapse in the exchange rate, or a high inflation
episode.
6
Table 1
CPI
1990-1994
1995-1999
2000-2004
2005-
Standard
Deviation
2.87
2.24
3.43
0.49
Average
12.45
7.36
5.51
3.46
During the recent period of relatively moderate inflation from 2000 to 2005, it is
indicated in Figure 2 that certain components of the CPI have experienced sharply
increasing prices, such as, petrol, tobacco products, and medical and education. Whereas
other items have seen moderate price increases, such as leisure, entertainment and
culture, and certain items, notably clothing and footwear, have experienced decreasing
prices over the period. It is also noteworthy that poorer households have experienced
higher inflation levels than households in the higher income quintiles during the 20002006 period (See Figure 3), although Bhorat and Oosthuizen (2006) present evidence that
there have also been earlier periods in which households from higher income quintiles
have experienced higher levels of inflation.
Figure 2
Commodities
CPI - COMPONENTS
Services
190
All items (The "general" index)
METROPOLITAN
Food
Cigarettes, cigars and tobacco
170
Clothing and footwear
Housing
Housing, gas, electricity and other fuels
COICOP
Fuel and power
Furniture and equipment
130
Household operation
Medical care and health expenses
110
Transport
Petrol
Communication
90
Recreation and entertainment
Leisure, entertainment and culture COICOP
MO042006
MO012006
MO102005
MO072005
MO042005
MO012005
MO102004
MO072004
MO042004
MO012004
MO102003
MO072003
MO042003
MO012003
MO102002
MO072002
MO042002
MO012002
MO102001
MO072001
MO042001
MO012001
MO102000
MO072000
MO042000
70
MO012000
2000 = 100
150
Reading matter
Education
Personal care
7
Figure 3
CPI BY INCOME QUINTILE
150
140
All items (The "general" index)
METROPOLITAN
Lowest quintile METRO
2000=100
130
Second quintile METRO
120
Third quintile METRO
Fourth quintile METRO
110
Highest quintile METRO
100
M
O
0
M 120
O
0 00
M 420
O
0 00
M 720
O
1 00
M 020
O
0 00
M 120
O
0 01
M 420
O
0 01
M 720
O
1 01
M 020
O
0 01
M 12
O 00
0
2
M 420
O
0 02
M 720
O
1 02
M 020
O
0 02
M 120
O
0 03
M 420
O
0 03
M 720
O
1 03
M 020
O
0 03
M 120
O
0 04
M 420
O
0 04
M 720
O
1 04
M 020
O
0 04
M 120
O
0 05
M 420
O
0 05
M 720
O
1 05
M 020
O
0 05
M 120
O
04 06
20
06
90
Since the year 2000 the low rate of inflation has been accompanied by an improved rate
of GDP growth, with the GDP growing at an average rate of 3,8% from 2000 to 2005,
compared to an average growth rate of 2,6% from 1995-1999 and an average growth rate
of 0,2% from 1990 to 1994 (see Fig.4).
Figure 4
% Change in GDP at c onstant 2000 pric es
6
5
3
Change in %
GDP at
c onstant 2000
pric es
2
1
05
20
02
20
99
19
96
19
-2
19
90
-1
93
0
19
% change
4
-3
8
Higher GDP growth rates would usually be associated with higher levels of inflation,
although this relationship breaks down during hyper inflation episodes where high levels
of inflation are associated with negative economic growth (Bruno and Easterly, 1998).
Disinflations from moderate to low levels of inflation, such as that which South Africa
has experienced over the past decade would normally be associated with retarded levels
of economic growth, referred to as the ‘sacrifice ratio’ in the literature.
Indeed, a cursory analysis of the data would seem to indicate that the high interest rate
episodes of 1998 and 2002 (See Fig 5), which were utilized by the policies to counter
inflationary pressures and facilitate ongoing disinflation, were associated with relatively
muted rates of economic growth, and it is likely that such an indication would be
confirmed by an output gap-based analysis that showed the departure of output from
potential or trend output. In 1998, short term interest rates rose to a high of 22,75% with
GDP growth falling to 0,5% in the year compared to the 2,6% average growth rate for the
period, and in 2002-2003, short-term rates rose to 13,55% and GDP growth in the years
averaged 3,3% compared to average growth rate for the period of 3,7%. Conversely, in
periods when interest rates were relatively low, output growth rates were relatively high,
such as the during the ‘low interest rate, high growth period’ from 2004 to 2006.
Figure 5
Negotiable Certific ates of Deposit - 3 Month
Rates
25
%
20
Negotiable
Certific ates of
Deposit - 3
Month Rates
15
10
5
2005/11/02
2003/11/02
2001/11/02
1999/11/02
1997/11/02
1995/11/02
1993/11/02
0
An interesting comparison can be made between the sharp interest rate response to a
negative currency shock during the 1998 Asian financial crisis and the 2001/02 currency
crisis (See Fig.6). During the 1998 crisis, monetary policy was used to target both the
internal and external value of the currency and inter alia high rates were used in an
unsuccessful attempt to avoid currency depreciation.
9
Figure 6
Real Effective Exchange Rate of the Rand
140
2000 = 100
130
120
110
Real Effective
Exchange Rate
of the Rand
100
90
80
70
2005/03
2003/01
2000/11
1998/09
1996/07
1994/05
1992/03
1990/01
60
During the 2001/02 currency crisis interest rates were increased, but not to the same
extent as during 1998, as the primary focus of the monetary authorities was on containing
inflation, rather than using interest rates to target the exchange rate. In this context the
inflation targeting regime has been regarded as reducing interest rate volatility in
response to shocks, such as a negative currency shock. The result of this is that real
factors, such as the rate of output growth, become less subject to volatility resulting from
monetary policy conduct.
An important objective of this study would be to use an analysis of price setting conduct
in the South African economy in order to test whether the inflation targeting regime has
impacted on price setting behaviour, and to gain insight into the manner in which price
setting behaviour has been influenced by currency and interest rate developments. Such a
study will have a bearing on establishing the extent to which monetary policy has gained
credibility.3
3
If price setters adjust their pricing conduct in line with reduced inflationary expectations, associated with a
credible monetary policy stance, then disinflations would be associated with a reduced sacrifice ratio, as
prices will be adjusted together with the monetary contraction in such a manner that these prices do not rise
in real terms which would result in no negative impact on levels of output and employment. If, on the other
hand, price setters do not view the monetary policy stance as credible and continue to set prices in line with
higher inflationary expectations then a monetary contraction will be associated with rising prices in real
terms resulting in negative pressures for output and employment, the so-called ‘sacrifice ratio’ associated
with low credibility disinflationary policy.
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1.c
Literature review
1.c.1
Specific gaps in South African literature
The research proposed would begin to fill a significant gap in South Africa’s economic
literature as studies on price setting, inflation, monetary economics and monetary policy
in South Africa have generally pursued a different set of questions from those under
discussion in this research proposal. Rather than focusing attention on price setting
behaviour in the South African economy, and the implications of such for the conduct of
monetary policy, recent South African research has focused on the implications of the
adoption of the inflation targeting policy framework, on modeling the causes of inflation,
on analysing the welfare effects of inflation and inflation-related policies, and on
studying the extent of exchange rate pass-through in the South African economy.
In their review of monetary policy in South Africa, Aron and Muellbauer (2005) argued
that wage setters in South Africa are backward looking as they indexing wages to past
inflation plus a “safety margin” in case inflation proves to be higher then expected. The
authors made the suggestion that if inflation targeting has the effect of reducing inflation
volatility this may lead to a reduction in the “safety margin” adopted by wage setters.
The authors also suggested a ‘cost channel’ effect whereby higher interest rates lead to a
higher cost of capital and wage pressures, which leads to price setting firms increasing
prices to pass on these costs, they suggest that the monetary policy’s focus on the CPIX
instead of on the CPI as the key inflation targeting bench mark may “wean price setters
off this mechanism”.
Fedderke and Schaling (2005) in their modeling of inflation in South Africa found
evidence of mark-up pricing. Nell (2000a) shows that inflation is largely due to higher
imported prices and wage rates (cost push inflation) in the period from 1984 to 1998, as
compared to demand pull factors in the 1973-1983 period. Roberts and Malikane (2005)
critique the narrow focus of inflation targeting, which is premised on the prevalence of
demand pull causes of inflation, when in fact inflationary pressures may be due to cost
push factors. The authors also highlight the negative welfare effects of high inflation on
goods purchased by low income households such as health care, education and food.
Bhorat and Oosthuizen (2006) studied the differential impact of inflation on rich and poor
South African households, showing the effects of distinctive ‘democratic’ and
‘plutocratic’ weightings of the Consumer Price Index. With regard to the impact of
exchange rate shocks on inflation in South Africa Bhundia (2002) finds that inflation is
more responsive to nominal shocks, when the currency depreciation was associated with
loosening of monetary policy, than to real shocks when the currency appreciated in
response to tighter than expected fiscal policy and a slow down in growth in the global
economy.
11
It can be concluded that a significant gap exists in the literature regarding price-setting
and the optimal conduct of monetary policy in the South African economy, a gap which
this research proposal intends to contribute towards filling.
1.c.2
Taking account of comparable international studies
A significant number of studies of price setting behaviour have been undertaken in a
range of economies and it would be beneficial for comparable studies to be undertaken in
the South African context. Survey’s of price setting behaviour include those of the
United States of America (Blinder 1998), France (Loupias et al, 2004), Spain (Alvarez
and Hernando 2005) and Canada (Amirault et al, 2006).
In addition, a significant number of microdata studies of CPI and PPI data have been
conducted in order to develop a detailed analysis of price setting behaviour in a range of
countries including: Euro Area (Alvarez 2005), Spain (Alvarez and Hernando’s consumer
price microdata study, 2004 and producer price study, 2005), France (Baudry et al, 2004),
Portugal (Dias et al, 2005), Israel (Baharad, 2003), and Sierra Leone (Kovanen 2006).
There is also an extensive literature measuring inflation persistence and which answers
questions regarding whether patterns of inflation persistence have changed as a result of
the introduction of the policy framework of inflation targeting, such as, Bleany (2001)
and Edwards and Lefort (1998).
The findings on comparable price setting surveys and data studies would assist in
understanding a range of features of price setting in South Africa, including the frequency
of price changes, the magnitude and direction of price changes and whether such price
changes can be shown to be time or state determined. Further, the survey methodology in
particular, allows for an evaluation of the relevance of various theories of price setting
behaviour which have been discussed in the literature, including certain theories that have
been evaluated through comparable surveys in other countries and other theories that
seem to have particular a priori application in the South African context.
1.c.3 Modeling the optimal conduct of monetary policy
Against this background, the proposed research will outline the implications of the
findings on price setting behaviour in the South African economy, for the optimal
conduct of monetary policy.
For this purpose the basic model developed by Altissimo, Ehrmann and Smets (2006)
will be adapted. This basic model includes a New Keynesian Phillips Curve relation, and
allows for discussion on varying degrees of price stickiness and backward lookingness in
price setting.4 The model is used to indicate the optimal response of interest rate policy
In the literature such models are referred to as utilising a “Hybrid New Keynesian Phillips Curve” as they
incorporate both forward looking firms, which set prices based on an optimisation strategy as well as
4
12
to cost push shocks. In this model optimality is measured in terms of minimising the loss
function associated with the variance and length of disturbance to output levels, and other
targeted variables, resulting from an increase in interest rates. It is proposed that this
basic model will be re-calibrated and adapted to suit key features of the South African
economy, in particular the model will be extended to deal with open economy dynamics
(as per Berg et al, 2006) as well as consideration will be given to selecting the most
appropriate measure of the output gap, or in selecting appropriate proxies for the output
gap, such as variations in marginal cost or variations in the labour share of income (see
discussion in Burger and du Plessis (2006)). Furthermore, other modifications and
extensions from the relevant literature will be considered.
For example, certain models, such as King and Wolman (1999), have been used to show
that optimal monetary policy entails zero inflation. Others have suggested that optimal
inflation would be slightly negative (Bakhshi, Martin and Yates (2002). Yet others have
argued that moderate positive levels of inflation lead to preferable outcomes. Akerlof,
Dickens and Perry (1996, 2000) indicated that at moderate levels of inflation near rational
economic agents do not adjust prices and wages to retain their real levels resulting in
increased levels of output, and Sinclair (2003) explained that due to a range of market
imperfections, including nominal rigidities and menu costs, a small positive inflation rate
constitutes an optimal monetary policy stance.
Kapadia (2005a) shows that if near rational price-setters assume that the inflation target
will be achieved and set their prices accordingly, then the economy’s response to cost
push shocks is improved in terms of relatively low levels of output and inflation
volatility. Furthermore, Kapadia (2005b) shows that in the context of hysterisis, the
monetary authorities should react less aggressively to cost push shocks.
A number of contributions have attempted to study the impact of both price and wage
rigidity on the optimal conduct of monetary policy such as Erceg, Henderson and Levin
(2000). Woodford (2003) counters that models which focus only on rigid prices (rather
than also on wage rigidities) are pedagogically simpler as the rate of inflation is a
measure of increasing goods prices rather than wages. He recalls that the observation of
infrequent changes in individual nominal wages does not in itself prove the existence of
nominal rigidities as employment is an ongoing relationship rather than a spot market
transaction and the existence of efficient implicit contracts may reflect workers
backward looking firms, which set prices based on the recent inflation path. The original New Keynesian
Phillips Curve only included forward looking firms, setting prices at an optimal level with the constraint
that in terms of Calvo’s (1983) pricing model a fixed number of firms (1- θ) were assumed to adjust prices
in each period, and as the (1- θ) number of firms adjusting prices in each period increased, the period for
which prices were fixed tended to be reduced. The original New Keynesian Philips Curve was thus
consistent with the optimizing behaviour of individual firms and households (Clarida et al, 1999, p.1665),
whereas the backward looking component of the hybrid approach introduces non-optimising or ad hoc
conduct. Much of the focus of research on both versions of the New Keynesian Phillips Curve has been to
use the Phillips Curve relation to attempt to model the determinants of inflation (Gali and Gettler, 1999),
rather than to determine the optimal conduct of monetary policy which is the focus of the current research
proposal. An important paper by Rudd and Whelan (2005), challenging Gali and Gettler’s (1999) findings,
has cast doubt on the New Keynesian Phillips Curve’s forward looking terms in explaining inflation
dynamics.
13
preferences for a smoother income stream. Nonetheless, Woodford does not rule out that
nominal wage stickiness may result in the stickiness in the effective nominal cost of labor
inputs and that models which include both wage and price stickiness may have something
to offer.
Models developed by Woodford (2003) and Romer (2000) utilize an interest rate as the
operating procedure of monetary policy, rather than the traditional IS-LM model in which
money supply targets are they key instrument of monetary policy. Woodford’s (2003)
emphasis on the interest rate instrument enables him to develop a non-monetarist
approach to the modeling of monetary policy (that is, one not based in the operational
control of the money supply). Woodford’s approach draws heavily on the Wicksellian
tradition’s conception of the natural rate of interest where, for example, an increase in the
natural rate of interest is not accompanied by an increase in the policy rate, this is
understand to amount to a loosening of monetary policy.
One of the purposes of this research is to use the established theoretical background to
develop a basic model, which is able formally to show how price rigidity impacts on the
optimal conduct of monetary policy. In particular, the model will allow for discussion on
the policy impact of the varying degrees of price rigidity and backward lookingness that
are found through survey and data research to be prevalent in the South African economy,
as well as for discussion on the optimal monetary policy response to cost push shocks
given the research’s findings on price setting behaviour.
1.c.4 The relationship between inflation and real variables
The proposed survey, empirical and theoretical research would take place against the
backdrop of an extensive literature modeling the relationship between monetary policy
and real economic variables. Phillips (1958) in his empirical study of the relationship
between unemployment and the rate of change of the money wage rate in the United
Kingdom found a negative relationship between the rate of change of money wages and
unemployment, which by Okun’s law was converted a positive relationship between
levels of inflation and levels of output. Friedman (1968) and Phelps (1967) countered
that if price and wage setters expectations regarding the impact of a monetary expansion
on inflation were taken into account, and if it were assumed that prices and wages were
perfectly flexible, then it could be shown that there no trade-off between inflation and
unemployment existed, and that any concerted attempt to use monetary policy to reduce
unemployment levels would result in an accelerating rate of inflation.5 This approach
5
According to the Friedman-Phelps critique, in the short-run, it may be the case that the lag in price
changes would be greater than the lag in output changes in response to a monetary expansion, leading to
real effects, but in the long-run, prices would adjust fully and only through a further monetary expansion,
and related increased inflation, could unemployment be reduced below the ‘natural rate’. The New
Keynesian focus on short-run demand management does not dismiss the Friedman-Phelps critique out of
hand, but is rather concerned about the optimal conduct of monetary policy in response to the shocks which
are regarded as an inherent characteristic of the macro-economy. While Friedman’s view in particular was
that policy makers would not be able successfully to intervene to stabilize aggregate demand, the
Keynesian view is that such short-run demand management interventions are needed, are possible and are
14
spawned an extensive literature on the non-accelerating inflation rate of unemployment
(the Nairu), which is synonymous with the natural rate or unemployment and associated
discussion concerning the validity and usefulness of the concept, Friedman (1968),
Stiglitz (1997), Blanchard and Katz (1997), Galbraith (1997), Bean (1994), Ball and
Mankiw (2002).
The Friedman-Phelps expectations critique did not put the matter to rest, due to a range of
empirical and theoretical challenges to the Friedman-Phelps approach. Empirically, there
was ongoing and wide-spread experience of a positive short-run relationship between
moderate levels of inflation and above trend output levels. To the extent that Taylor
(2000) included the absence of a long-run trade-off between inflation and employment
and the presence of such a short-run trade off as one of “five things we know for sure”
about the United States economy. Although, for the South African economy, Hodge
(2002) reports little evidence supporting a short-run trade-off between inflation and
employment (or economic growth).
Theoretically, too, there were challenges to the key Friedman-Phelps assumption that
forward looking rational economic agents could, and would, fully adjust prices and wages
in such a way as to neutralize completely the effect of monetary policy changes on real
variables. A wide range of challenges to the Friedman-Phelps critique were delivered.
Lucas (1973) advanced the view that even rational economic agents would be likely to
have misperceptions as to the extent to which a generalized price increase also
represented, in part, a relative price increase for the goods which they produce, resulting
in a positive relationship between levels of output and levels of inflation. Taylor (1977)
developed a staggered price setting model (as apposed to Friedman-Phelps’ flexible price
model) and used it to show that if there were expectations that levels of demand and
output would be higher in the future periods then prices would be set at a higher level for
these future periods, thus positing a positive relationship between levels of output and
levels of inflation. Fischer (1979) developed a sticky wage model which provided for a
positive relationship between rising prices (leading to lower real wages as nominal wages
had been set in advance) and rising levels of output (although the positive empirical
relationship between output and real wages runs counter to the assumption of the negative
relationship between output and real wages upon which Fischer’s model was built).
The notion that “temporary nominal rigidities provide the key friction that gives rise to
non-neutral effects of monetary policy” become the unifying theme in what has come too
be known as the New Keynesian perspective (p.1662, Clarida, Gali and Gertler, 1999).
desirable (Modigliani, 1977). Recent inflation targeting literature (such as Mishkin 1997) has focused
sharply on the extent to which inflationary expectations and price setting conduct will be influenced by
short-run monetary interventions, and for this reason even discussion on short-run demand management
policy has come to be concerned with issues of the price stability credibility of the monetary authorities and
to a significant extent even Keynesian-type discussion on effective short-run demand management in
response to shocks, is premised on the understanding that an underlying commitment to price stability
(usually in the form of an inflation targeting framework) is a necessary precondition for the effective
conduct of monetary policy, even in so far as the stabilisation of output and other real factors are
concerned.
15
Akerlof and Yellen (1985) based their approach on an assumption of ‘near rationality’,
where economic agents were assumed not to fully adjust prices and wages in the context
of moderate levels of inflation as the costs of not doing so are minimal as compared to the
non-adjustment costs during high inflation episodes, with a resulting positive relationship
between moderate levels of inflation and growth in economic output.
16
Section 2: Survey of price setting behaviour in the South African economy
2.a
Overview
It is envisaged that survey would include face-to-face interviews with 100 business
decision makers drawn from a representative sample of the targeted component of the
GDP. There will be a pilot survey of 10 interviews allowing for any modifications to the
questionnaire that may be necessary for purposes of clarity and given the objectives of
the study.
The objective of the survey would be better to understand price setting behaviour in
South Africa, both from the perspective of such issues as how frequently prices are
changed and how quickly prices respond to cost shocks and demand shocks, but also
from the perspective of trying to evaluate the validity of various economic theories of
price setting behaviour from the angle of price setters themselves.
The former aspect can at best be regarded as a complement to econometric studies of
micro-level pricing data, but the latter aspect of understanding the extent to which the
motives price setters accord with pricing theory is often best served by survey methods as
econometric techniques are stymied by the prevalence of non-observable variables. For
example, Blinder posits that Okun’s (1981) ‘invisible handshake’ theory of implied
contracts is “an example of where direct econometric testing seems out of the question…
The idea behind the theory is that firms have implicit understandings with their regular
customers which proscribe price increases in tight markets, presumably in return for
stable prices in weak markets. [No econometric testing can be done on such implied
agreements], but it seems that, if such tacit agreements exist. Firms ought to know that
they do – and should say so when asked.” (p.9 Blinder et al 1998,)
This is not to say that the interview methodology is without limitations. In particular, the
methodology is sensitive to the wording of questions, as in this case where theories of
price setting are to be de-jargonised and written in plain language. It is also noteworthy
that various survey methods have been adopted, such as, by phone, mail and face to face
interviews, with a reported tendency for fewer non-answers when fact to face interviews
are conducted.
2.b
Sample selection
Following Blinder et al (1998) the targeted survey sample will be the private, for-profit,
un-(price)-regulated, nonfarm component of the GDP, which in the US amounted to
about 71% of total GDP and in South Africa would amount to about 67% of the GDP
broken down in Figure 7 as follows:
17
Figure 7
Sectors targeted for survey - 2005 Major divisions of SIC (67% of GDP)
Financial Intermediation,
Insurance, Real Estate and
Business Services
31%
Manufacturing
28%
Manufacturing
Construction (Contractors)
Construction (Contractors)
4%
Transport, Storage and
Communication
15%
Wholesale and retail trade, catering and
accommodation
Transport, Storage and Communication
Financial Intermediation, Insurance, Real
Estate and Business Services
Wholesale and retail trade,
catering and
accommodation
22%
Following Blinder et al (1998) the exclusions are explained as follows. The focus is on
the private sector as theories of price setting are used to explain behaviour of profit
maximizing firms. The price-regulated sector is excluded as in this sector price rigidity is
either trivial to explain (as flexibility is illegal) or requires a complex theory of
government regulatory behaviour. Farms excluded as farm prices are not perceived to be
sticky.
2.c
Substance of the survey
Firstly, price setters would be asked a number of descriptive questions to ascertain the
main sector in which their firm operates and the degree of competition or the firm’s
market power within the specific sector, as well as the firm’s pricing practices, including
the frequency of price reviews and how responsive price setters are to changes in costs
and changes in demand.
Secondly, price-setters would be asked to score, from 1 to 4, the importance of a limited
number of theories of price setting behaviour in explaining their firms price setting, with
a score of 1 indicating that the theory rated “totally unimportant”, a score of 2 indicating
that the theory rated “of minor importance”, a score of 3 indicating that the theory rated
“moderately important”, and a score of 4 indicating that the theory rated “very
important”. Some of the theories to be tested will be drawn from those used in Blinder et
18
al’s 1998 study and other’s will be selected due their a priori relevance to South Africa’s
economic conditions.
From Blinder’s study, the top rated theories of pricing behaviour were coordination
failure (where firms hold back on price changes, waiting form other firms to go first),
cost-based pricing (where price rises are delayed until costs rise), nonprice competition
(where firms vary nonprice elements such as delivery lags, service or quality) and
implicit contracts (where firms tacitly agree to stabilize prices, perhaps out of “fairness”
to customers). Moderately rated theories of price setting were nominal contracts (where
prices are fixed by contracts), costly price adjustment (where firms incur costs of
changing prices), procyclical elasticity (where demand curves become less elastic as they
shift), and pricing points (where certain prices - like R99,99 - have special psychological
significance). Poorly rated pricing setting theories were constant marginal costs (where
marginal cost is flat and markups are constant), inventories (where firms vary inventory
stocks instead of prices), hierarchy (where hierarchical delays slow down decisions) and
judging quality by price (where firms fear customers will mistake price cuts for
reductions in quality).
Given South Africa’s economic conditions, other approaches to price setting to be
considered for incorporation into the survey would include the following:
a question as to whether pricing decisions are aligned to the stated inflation target
(as per Kapadia 2005),
a question as to whether pricing decisions take into account future inflation (based
on Blanchard’s commentary in Blinder 1994),
a question on whether indexing of price changes to past inflation levels is
prevalent,
a question as to whether price adjustments are more likely when inflation is high
and that there is likely to be no adjustment when inflation is low (Akerlof et al
2000),
a question as to whether changes in interest rates impact on price setting conduct
(cost channel literature as per Barth and Ramey 2000)6,
6
Here it may be useful to discuss the scenario where an increase in interest rate would be associated with a
decrease in prices. An increase in interest rates is associated with decreased components of demand, such
as, decreased investment, decreased consumption, and decreased government spending, which should be
associated with price decreases and/or reduced levels of price increases. Discuss evidence of the impact of
negative demand shocks on price-setting behaviour in South Africa. A rate increase is also associated with
a currency appreciation which effectively dampens demand as exports become less competitive and there is
increase competition from imports, putting downward pressure on prices. The reverse case is where a
reduction in interest rates, leads to increased demand as consumption, investment and government spending
increases. In this context prices would be expected to rise, particularly if asset effects such as increased
housing values are taken into account. It would be interesting to assess how price setters in South Africa
have responded to lower rates or if other factors, such as co-ordination failure or other theories of price
stickiness, have dampened expected price increases. Consider also that in an open economy, reduced rates
should be associated with a currency deprecation and increased levels of foreign demand and reduced
import competition, putting upward pressure on prices, but that in South Africa capital inflows have
resulted in currency strength, re-enforcing price dampening due to competition from imports and dampened
foreign demand. Discuss evidence of the effect of currency strength on price-setting behaviour in South
Africa.
19
-
a question as whether prices are raised in order to reach revenue targets in the
context of decreased demand7,
a question on the impact of wage setting on price setting,
a question on the impact of exchange rate volatility on price setting conduct,
a question on the impact of import parity pricing, and
a question on the impact of trade liberalisation.
2.d
Survey Findings
The survey will reveal two sets of findings: descriptive findings and theory-evaluation
findings. Descriptive, findings for South Africa will include an estimation of how
frequently prices are adjusted in the South African economy, and an estimation of how
long are the lags in price adjustment following a cost or demand shock.
Blinder et al’s 1998 finding for the frequency of price changes the US economy is that
there is significant price stickiness as about 78% of the relevant sample of the GDP is
repriced quarterly or less often, as per Table 2.
Table 2
Number of price changes in a typical year (n=186 responses)
Frequency
Percentage of Firms
Cumulative Percentage
Less than 1
10,2%
10,2%
1
39,2%
49,4%
1,01 to 2
15,6%
65,0%
2,01 to 4
12,9%
77,9%
4,01 to 12
7,5%
85,4%
12,01 to 52
4,3%
89,7%
52,01 to 365
8,6%
98,6%
More than 365
1,6%
100,0%
Median = 1,4
In addition to asking about the frequency of price adjustments, the conceptually superior
question for analyzing the degree of price stickiness is how long it takes for prices to
adjust after a demand or cost shock. Blinder et al’s 1998 findings in this regard for the
United States are outlined in Table 3.
7
Such an effect may occur as result of the manner in which price-setters react to a negative demand shock
associated with an interest rate increase. In this scenario price-setters react to reduce demand by increasing
prices. They do this in an attempt to achieve pre-established revenue targets for their firms (as raised in
discussion with Brian Kahn). This approach would be pertinent where price-setters have pricing power and
may result in a positive relationship between interest rates and prices, even where there is no transmission
of higher interest rates to higher prices along the cost channel, for example where firms retain sufficient
cash balances and do not need to borrow in order to fund new investment. It would be interesting to
discuss whether there is evidence of such an effect in South Africa.
20
Table 3
Lags in Price Adjustments, in Months
Type of Shock
Mean lag Standard
Number
Deviation
Responses
Increase in Demand
Increase in Cost
Decrease in Demand
Decrease in Cost
2,9
2,8
2,9
3,3
3,2
3,0
3,7
3.9
128
163
132
101
of Number of “It
never
happens”
52
23
52
73
The survey will also include an open ended question about why prices are not changed
more frequently, which leads to difficult characterization problems, but has the advantage
that “it gives respondents a chance to choose their favourite explanation for price
stickiness before their minds are contaminated by hearing any other suggestions” (Blinder
et al, 1998, p.85).
The survey will be designed in such a way that interesting, direct comparisons can be
made in this regard to the descriptive results of price-setting surveys conducted in other
countries.
Theory-evaluation findings will include an evaluation of the applicability of competing
theories of price setting behaviour in the South African context. Such findings will be
presented on an aggregate basis as well as on a by industry basis.
Analysis of survey data would include an ordered probit analysis of the survey results to
assess how the observable attributes of various firms assist in explaining the importance
which price-setters attach to each theory of price stickiness. Such an analysis will assist
in generating an extensive set of formal findings. For example, Blinder et al (1998),
found that firms in the construction and mining sector are unlikely to regard adjustment
costs (or menu costs) as an important reason for price stickiness.
In this regard, Blinder et al’s (p.249, 1998) findings regarding the importance of
adjustment costs (or menu costs) are as follows:
The Importance of Menu Costs (Theory B8) = – 1,84 CON – 1,46 RETAIL – 0,57
WHOLESALE + 0,46 FLATMC – 0,35 CYCLICAL + 0,008 CONSUMER – 0,15
WRITTEN – 0,48 LOYAL
This indicates inter alia that construction and mining as well as retail trade firms are less
likely to view adjustment costs as an important source of price stickiness (perhaps
because construction firms work to order and mining output is sold in flexible price
markets). In addition firms with written contracts are less likely to perceive adjustment
costs as an important source of price rigidity. Further, direct comparison with Blinder et
al’s (1998) analytical results would be facilitated by the fact that Blinder’s data is
available in Stata file format.
21
22
Section 3 Undertake a micro-data analysis South Africa’s price data as a basis for
analysing price setting behaviour.
3.a Overview
An empirical analysis of the large sample unit level or microdata set of the Consumer
Price Index (CPI) is proposed8, which will allow findings to be made on the following
issues: the frequency of price changes (and the related duration of price setting) in the
South African economy, and the size and direction of price changes in the South African
economy. The study will be structured as follows (as per Alvarez and Hernando, 2004).
3.b
Analysis of frequency of price changes
As per Table 4’s results for Spain (from Alvarez and Hernando, 2004), findings for the all
items of the CPI will include findings as to the frequency of price changes (measured in
terms of the average proportion of prices changing each month over the most recent 45
month period for which data is available from Statistics South Africa). For example,
50% of unprocessed food prices change each month, with 26% of unprocessed food
prices rising each month and 23% of unprocessed food prices declining each month.
8
This will require access to the very large data sets at unit level of South Africa’s CPI data and the
utilization of techniques for analyzing the frequency, size and timing of price changes using this data, based
on the methods adopted by Alvarez and Hernando (2004). In terms of their approach, it was accepted that
restrictions were to be applied in defining the sample to ensure adherence to the legal requirement to
preserve the confidentiality of the data. Each individual price record corresponded to a precisely defined
item sold in a particular outlet in a given city at a given point in time (therefore individual items can be
followed over time within the same outlet). Along with each individual price quote the following
additional information was provided: The year and month of the record; the item code, which allows the
subclass to which the item belongs to be identified (roughly down to the COICOP 5 digit code)
(Classification of Individual Consumption According to Purpose); a numeric outlet code, which does not
enable the name of the outlet to be identified; a numeric city code, which does not permit the name of the
city to be identified; a numeric code to specify whether the item is a good or a service; where substitutions
in products have occurred, the study will rely on the adjustments made by the statistical authorities;
periodicity of data collection is product dependent, although prices are normally collected monthly. Where
prices are collected 3 times per month (e.g. fresh fruit and vegetables) the Statistical authority provided the
price corresponding to the first week of every month. If data was collected quarterly then a carried forward
procedure is adopted and the price is assumed to remain the same throughout the period. Sales and
promotions prices were excluded from Spanish data leading to a lower frequency of price adjustment than
would be the case if such prices were included. Also Energy prices which change frequently were excluded
and administered prices, which experience low frequency price changes were excluded. In Spain the dataset
covered 70,1% of the expenditure on the CPI basket, with exclusions corresponding to those product
categories whose prices are collected in a centralized way e.g. housing rents, energy, telecommunications,
care prices, tobacco, financial, insurance and household service, etc. Also administered prices were
excluded except those determined at a regional or local level.
23
The study will also enable findings as to whether price setting is asymmetrical or
symmetrical upwards and downwards. Similarly, findings for the main components of
the CPI will include a finding per component (at a South African specific level of
disaggregation as per Figure 2 above) as to the frequency of price changes and the
directional symmetry of price changes. A finding will also be made as to whether the
frequency of price setting is homogenous or non-homogenous across product categories.
Table 4
Monthly frequency of price changes
Main
Frequency of Frequency of
component
price changes
price increases
0,50
0,26
Unprocessed
food
0,11
Processed food 0,18
Frequency of % of price
price decreases increases
0,23
53.1%
0,07
59,0%
Non-Energy
industrial
goods
Services
0,07
0,05
0,02
74,9%
0,06
0,05
0,01
86,5%
All items
0,15
0,09
0,06
62,2%
An analysis of factors influencing the frequency of price setting is also proposed,
including such factors as seasonality, the prevailing rate of inflation, preference for round
prices, changes in excise duties, and a number of factors not included in the Alvarez and
Hernando study, but which have an a priori applicability to South Africa including
exchange rate developments, wage setting developments, the degree of competition or
market power of price setters, and interest rate developments (relevant to an analysis of
the cost channel of South Africa’s monetary policy transmission mechanism).
3.c
Analysis of size price changes
As per Table 5’s results for Spain (from Alvarez and Hernando, 2004), expected findings
for South Africa for all items of the CPI will include the average percentage change in
prices for all items, average price increase, and average price decrease (assuming a
maximum of one price change per period). Similarly, findings for the main components
of the CPI will reveal what is the average price change, the average price increase, and
the average price decrease per component (at a South African specific level of
disaggregation, as per Figure 2 above).
24
Table 5
Size of Price Changes
CPI Component
Average
Price Average
Change
Increase
14,9%
Unprocessed Foods 15,2%
Price Average
Decrease
-15,6%
Processed Food
7,3%
6,9%
-8,0%
Non-energy
industrial goods
Services
6,5%
6,1%
-8,3%
8,4%
8,2%
-11,2%
All items
8,6%
8,2%
-10,3%
Price
An analysis of factors influencing the size of price changes is also proposed, including
such factors as seasonality, the prevailing rate of inflation, preference for round prices,
changes in excise duties, and a number of factors not included in the Alvarez and
Hernando study, but which have an a priori applicability to South Africa including
exchange rate developments, wage setting developments the degree of competition or
market power of price setters, and interest rate developments.
It may then be possible to conduct an analysis of whether price setting in South Africa is
state dependant or time dependant (as per model developed by Dias D et al, 2005) and to
conduct a comparison of results for the South African economy with the results for other
countries where such micro level price data analysis has been undertaken.
25
Section 4:
4.a
Modeling the implications of pricing behaviour for the optimal
conduct of monetary policy in South Africa
Overview
This section will be introduced with a review of recent theoretical and VAR studies
which show how monetary policy shocks are modeled to result in changes in output and
other real variables if there is a prevalence of nominal rigidities, and a discussion on the
applicability these findings to South Africa.
An analysis of the policy implications of the findings of the study into price setting
behaviour would include discussion on the following dialectic. Firstly, an assessment of
how interest rate changes influence price setting behaviour by South African firms,
which would bring into discussion the relative significance of cost channel effect (as
rising interest rates put upward pressure on prices) and negative demand effects (as rising
interest rates put downward pressure on prices). Secondly, a discussion on how an
understanding of price setting behaviour should influence the conduct of monetary policy,
as the existence of price rigidities means that monetary policy decisions impact on short
to medium term output and employment levels. An understanding of the short-term real
effects of interest rate policy would improve the understanding of the manner in which
price rigidities impact on the real outcomes of monetary policy, even in the context of the
inflation targeting framework which largely for tactical reasons chooses to de-emphasize
discussion on the output effects of monetary policy.
This will serve to introduce an important objective of the research which is formally to
show the implications of price setting for the optimal conduct of monetary policy in
South Africa. The precise manner of this integration will depend on the details of the
research findings. Nonetheless, it is possible to discuss the type of model which will be
developed.
4.b
Modeling the implications of pricing behaviour
A model such as that developed by Altissimo et al (2006) would assist in the analysis of
monetary policy in the context of varying degrees of price rigidity. Altissimo et al’s
model is based on a Phillips Curve, IS curve and Taylor rule and is used to show that in
comparing situations of high and low degrees of price rigidity, monetary policy should be
less aggressive in the face of cost push shocks in order to achieve preferable output, real
interest rate and inflation outcomes. This is because if prices are relatively sticky there
will be a greater short-run reduction in output due to an interest rate increase and a
greater increases in output when interest rates are reduced.
26
The Altissimo et al model is based on a Hybrid New Keynesian Phillips Curve, an IS
curve and a Taylor rule, as follows:
Phillips curve:
IS Curve:
Taylor Rule:
Where:
   t 1  (1   ) E t 1  y1  t
yt  yt 1  (1   ) Et yt 1   (rt  Et t 1 )   t
rt  rt 1  (1   )(  Et t 1  Et yt 1 )
π = inflation
y = the output gap
E = expectations operator
u = a cost push shock
ε = a demand shock, and
r = the policy rate
κ = the degree of response of inflation to output
σ = variance of cost push shocks
λ = extent of interest rate smoothing by authorities
γ = proportion of backward looking or price-indexing firms
For their study of the Euro area Altissimo et al (2005) calibrated their model using Smets
(2004) with the degree of price stickiness affecting the response of inflation to output, κ,
as well as the variance of cost-push shocks, σ. With stickier prices being associated with
smaller κ and σ values. As indicated by Diagram 1 below the model has different
outcomes depending on whether the degree of price stickiness in the economy is low
(prices set for two quarters), medium (prices set for three quarters) or high (prices set for
four quarters). The diagram indicates the impact of the degree of price stickiness on the
response of output, inflation and the nominal and real policy rates.
In the model, the response to a cost-push shock which threatens rising prices π is an
increase in the policy interest rate (Taylor rule), leading to a restraining of output growth
(IS curve) which leads to reduced pricing and containment of inflation (Phillips curve).
Where there is a higher degree of price stickiness, this leads to a more persistent output
response, whereas the effect on the shape and the magnitude of the inflation response is
relatively minor. Under the optimal monetary policy (which entails less of a policy rate
increase where prices are relatively sticky), the path for inflation does not depend very
much on the degree of price stickiness, but a higher degree of price stickiness implies that
the overall sacrifice ratio involved in achieving this inflation path is higher. For similar
profiles of inflation, the cumulative output loss is shown to be highest where price
stickiness is highest.9 As a result, an optimal monetary policy response would entail a
9
In this regard, the minimization of a loss function, such as the following, may be used to assess the optimal
conduct of monetary policy as it penalizes deviations from employment, inflation and output growth
targets: L = a1(U-U*)2 + a2(P-P*)2+a3(Y-Y*)2 where a1, a2, a3 >0. Consideration will be given to applying a
variety of weighting options for a1, a2, and a3 in order to assess the impact for the research findings of
27
less aggressive monetary policy reaction, that is, a less aggressive increase in the nominal
interest rate.
There are two key reasons why a higher degree of price stickiness implies a less
aggressive monetary policy reaction. Firstly, due to price stickiness a given increase in
the nominal interest rate will have a larger effect on the real rate and on output.
Secondly, with higher price stickiness, credible monetary authorities have a greater
incentive to smooth out their policy response, resulting in smaller initial output gap
response, but one which is prolonged and cumulatively significant.
The model also provides for analysis of the optimal conduct of monetary policy in the
context of varying degrees of backward-lookingness or price-indexing by firms (indicated
by γ in the model).
Diagram 1
differing policy stances of the authorities regarding the relative importance of their inflation, growth and
employment objectives.
28
In this section of the research, the findings concerning price setting behaviour in the
South African economy will be used to calibrate an adaptation of the model appropriate
to South African conditions. This will include estimations of price stickiness and
backward lookingness or indexation for the South African economy, which may also
entail a decision on whether to use the original version of the New Keynesian Phillips
Curve or the hybrid version with both forward and backward looking components.
Further adjustments will need to be made to the model, in particular the model will be
extended to deal with open economy dynamics suitable to the South African situation,
and consideration will be given to selecting the most appropriate measure of the output
gap, or in selecting appropriate proxies for the output gap, such as variations in marginal
cost or variations in the labour share of income.
In developing the open economy aspect of the model, direction could be taken from the
approach developed by Berg et al (2006) to develop a four equation, explicitly open
economy, model including: (1) an aggregate demand or IS curve that relates the level of
real activity to expected and past real activity, the real interest rate and the real exchange
rate; (2) a price-setting or Phillips Curve that related inflation to past and expected
inflation, the output gap, and the exchange rate; (3) an uncovered interest parity condition
for the exchange rate, with some allowance for backward-looking expectations; and (4) a
rule for setting the policy interest rate as a function of the output gap and expected
inflation. This model expresses each variable in “gap” terms, or in terms of its deviation
from equilibrium, rather than explaining movements in equilibrium values of real output,
the real interest rate, the real exchange rate or the inflation target.
Price setting evidence such as that to be gathered in the research has been found to
present challenges to the assumptions underlying micro-founded macro models, and the
incorporation of such evidence may serve to improve the micro-foundations of macroeconomic modeling of the optimal conduct of monetary policy (Angeloni et al, 2005).
4.c
Conclusion
This will include a discussion on how the findings on price setting behaviour in South
Africa impacts on aspects of the monetary policy transmission mechanism, for example,
through assessing the extent to which firms adjust prices as a result of interest rate
movements. Further it will summarise the analysis of how price setting behaviour has
been shown to impact upon the optimal conduct of monetary policy, particularly in the
context of cost-push shocks. The research will conclude with an integration of the
theoretical and empirical results into a discussion about the optimal conduct of monetary
policy in South Africa.
29
Section 5:
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