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Trade-Openness, Consumer Price Inflation and Exchange Rate Depreciation Shocks

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Capital Flows, Credit Markets and Growth in South Africa

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Abstract

This chapter examines whether an unexpected increase in trade-openness has any direct effect on the exchange rate pass-through (ERPT) and if it also impacts the reaction of consumer price inflation (inflation) to exchange rate depreciation shocks. Evidence indicates that an unexpected increase in trade-openness significantly lowers the size of the exchange rate pass-through to inflation. In addition, inflation rises less in the presence of trade-openness than is the case when trade-openness is not considered. Thus, increased trade-openness mitigates the rise in consumer price inflation due to exchange rate depreciation shocks. This evidence implies that if rising trade tensions between China and the United States of America (US) does not reduce the size of the South African trade-openness, the size of the ERPT will be smaller compared to when trade-openness starts shrinking significantly. This implies that the size of the interest rate adjustments based on the projected interest rate path will probably exhibit an upward bias if it does not consider that increased trade-openness reduces the size of the ERPT. Therefore, the conduct of monetary policy may benefit much from the impact of increased trade-openness on the size of the ERPT.

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Notes

  1. 1.

    A high degree of the exchange rate pass-through for developing economies has been cited as the rationale for the developing countries’ well documented fear of floating. Whether the ERPT is high or not matters for the determination of the trade balance.

  2. 2.

    Literature findings and theory do not only point to a negative relationship between trade-openness and the ERPT, but to an ambiguous association. For instance, Ozkan and Erden (2015) suggest that the impact of trade-openness on the ERPT is rather ambiguous from a theoretical perspective. High trade-openness may enable the exchange rate changes to be easily transmitted, and this gives rise to a high ERPT. Moreover, Benigno and Faia (2010) argue that globalisation (or trade-openness) reflected by greater competition implies a higher ERPT. This arises when greater competition due to the increase in the share of foreign products in a specific industry raises the degree of the exchange rate pass-through.

  3. 3.

    The book is titled “Exchange rate passthrough, second round effects and inflation process: Evidence from South Africa”.

  4. 4.

    This could be explained by foreign exporters’ willingness to maintain market shares in large markets.

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Authors and Affiliations

  1. South African Reserve Bank, Pretoria, South Africa

    Nombulelo Gumata & Eliphas Ndou

  2. Wits Plus, University of the Witwatersrand, Johannesburg, South Africa

    Eliphas Ndou

  3. School of Economic and Business Sciences, Johannesburg, South Africa

    Eliphas Ndou

Authors
  1. Nombulelo Gumata
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  2. Eliphas Ndou
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Gumata, N., Ndou, E. (2019). Trade-Openness, Consumer Price Inflation and Exchange Rate Depreciation Shocks. In: Capital Flows, Credit Markets and Growth in South Africa. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-30888-9_4

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  • DOI: https://doi.org/10.1007/978-3-030-30888-9_4

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  • Print ISBN: 978-3-030-30887-2

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