Inflation targeting in South Africa: A VAR analysis

The first part of the paper analyses CPI inflation targeting in an open economy context. Inflation targeting makes the exchange rate less flexible in response to foreign shocks and thus lessens the automatic stabilisation provided by flexible exchange rates. The second part uses VAR techniques to study the relative frequencies of different kinds of shocks impinging on the South African, New Zealand and Canadian economies. The results suggest that South Africa is not a good candidate for an inflation target relative to the other two countries because of the relative importance of foreign shocks and of the weak linkage between monetary policy and inflation.