Do Credit Regimes Play a Role in the Pass-Through of the Exchange Rate Depreciation Shocks to Inflation?

Abstract

This chapter contributes to the debate on the exchange rate pass-through (ERPT) to inflation by considering the role of credit growth regimes. Regime-dependent VAR and linear threshold approaches were used to determine the extent to which credit regimes impact the pass-through of rand depreciation shocks to inflation. Evidence from the regime-dependent VAR approach and threshold linear regression establishes that rand depreciation shock increases inflation in the high credit regime. Furthermore, the rand depreciation shocks explain more variation in inflation in the high credit regime than in the lower regime.

The policy implication is that credit growth below the threshold of 9.5 per cent assists in containing demand-driven inflationary pressures and thus plays a role in neutralising the degree of the ERPT of the rand depreciation shocks to inflation. Within the context of the interaction of price and financial stability it seems to be the case that such a threshold can serve as one of the benchmarks to assess the build-up of potential threats to both policy objectives. In policy perspective, it can assist within the financial regulatory framework as one of the reference points to activate tools aimed at restricting credit-driven demand pressures and overheating, whilst assisting in lowering the degree of the ERPT to inflation in the process.