Inflation targeting and the fisher effect in South Africa: An empirical investigation

The paper analyses the relationship between expected inflation and nominal interest rates during a period of inflation targeting in South Africa, i.e. from 2000 to 2005. Specifically, it investigates the Fisher hypothesis that nominal interest rates move one-to-one with expected inflation, leaving the real interest rate unaffected. The analysis distinguishes between a short-run Fisher effect and a long-run Fisher effect. Using cointegration and error correction models (for monthly data for the period April 2000 to July 2005), it was found that the short-run Fisher hypothesis did not hold during the relevant period under the inflation targeting monetary policy framework in South Africa. This is attributed to a combination of the South African Reserve Bank's (SARB) control over short-term interest rates and the effects of the monetary transmission mechanism. The long-run Fisher hypothesis could not be confirmed in its strictest form: while changes in inflation expectations move in the same direction as the nominal long-term interest rate. This suggests that monetary policy has an influence on the real long-term interest rate, which has positive implications for general economic activity, thus confirming the credibility of the inflation targeting framework.