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Negative Terms-of-Trade Shock, the Real Effective Exchange Rate and Repo Rate Adjustments

  • Eliphas Ndou
  • Nombulelo Gumata
Chapter
  • 364 Downloads

Abstract

Policymakers do not observe shocks individually. This chapter assesses the net effects of the concurrence of negative terms-of-trade and oil price shocks on inflation, and the response of the policy rate. Evidence is presented to show that the adjustment of the trade balance to positive terms-of-trade shocks is consistent with the Harberger-Laursen-Metzler (HLM) effect. This means that the adjustment of the trade account is characterised by the dominance of the consumption-smoothing effect over the investment effect. Therefore, growth in terms-of-trade does not necessarily induce agents to significantly alter the capital stock.

The net effects of negative terms-of-trade and oil prices shocks indicate that a decline in oil price cushions GDP and consumption. But the positive net benefits of the oil prices on consumption are very transitory. The depreciation of the real effective exchange rate (REER) coincides with positive contributions to GDP and consumption. But the REER depreciates for more than a year, which is long enough to lead to highly persistent inflationary pressures. The repo rate tightens in response to the expected inflationary pressures associated with the depreciation in the REER.

Is monetary policy constrained by terms-of-trade shock? Based on the threshold effects of terms-of-trade, evidence shows terms-of-trade shocks are not a binding constraint on monetary policy. Policymakers are able to execute their mandate in pursuit of price stability irrespective of terms-of-trade regimes.

Keywords

Monetary Policy Trade Balance Consumption Expenditure Inflationary Pressure Real Effective Exchange Rate 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

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Copyright information

© The Author(s) 2017

Authors and Affiliations

  • Eliphas Ndou
    • 1
  • Nombulelo Gumata
    • 1
  1. 1.South African Reserve BankPretoriaSouth Africa

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