Abstract:
In this paper, we estimate the long-run equilibrium relationship between money balance as a ratio
of income and the Treasury bill rate for the period of 1965:02 to 2007:01, and in turn use the
relationship to obtain welfare cost estimates of inflation. Using the Johansen technique, we
estimate a log-log specification and a semi-log model of the above relationship. Based on the fits
of the specifications, we decided to rely more on the welfare cost measure obtained under the
log-log money demand model. Our estimates suggest that the welfare cost of inflation for South
Africa ranges between 0.34% and 0.67% of GDP, for a band of 3-6% of inflation. Thus, it seems
that the South African Reserve Bank’s current inflation target band of 3-6% is not too poorly
designed in terms of welfare.
