Abstract:
The successful conduct of monetary policy relies on accurately characterising inflation's data
generating properties. Monetary policy errors that allow inflation to transition to a high
inflation regime that is very persistent might have costly economic implications as the central
bank attempts to bring inflation to a lower regime, say at some target level. This paper studies
the duration of inflation persistence over time and across various policy regimes. We test the
inertial properties of South African inflation in a Markov-Switching autoregressive fractionally
integrated moving average model. We isolate period of high inflation and low inflation and
analyse how persistent it is. This is an unique application to South Africa. The use of a
fractional differencing ARIMA model allows for the possibility that inflation is close to a unit
root, however, still mean reverting. This implies that shocks to inflation is very persistent and
take long to dissipate. The inflation persistence is measured using a test by Ng and Perron
(2001). We show that inflation is more persistent during high inflation episodes relative to low
inflation episodes and more volatile during low inflation periods compared to high inflation
periods. We estimate that it takes approximately 70 months for 50 percent of the shocks to
dissipate in a high inflation regime compared to 10 months in a low inflation regime. The model
identifies three structural breaks - a low inflation regime from 1920 until 1960, a high inflation
regime from 1961 until 2003, and another low inflation regime over part of the inflation
targeting period, 2003-2014. We also show that inflation persistence in the high inflation
regime transitioned to a low inflation regime only much later than the implementation of
inflation targeting - hinting that agents take time to adjust expectations. This has an important
consequence for monetary policy - monetary policy errors that allow inflation to transition to a
high inflation regime may take many months for any corrective policy to become effective.
