Monetary Policy Frameworks for Emerging Markets

Monetary Policy Frameworks for Emerging Markets

Edited by Gill Hammond, Ravi Kanbur and Eswar Prasad

Financial globalization has made monetary policy formulation in emerging market economies increasingly complicated. This timely set of studies looks at the turmoil in global financial markets, which coupled with volatile inflation poses serious challenges for central banks in these countries. Featuring papers from the research frontier and front-line policymakers in developing and emerging market economies, the book addresses questions such as ‘What monetary policy framework is most suitable for these countries to confront the new challenges while they continue to open up to trade and financial flows?’, ‘What are the linkages between monetary stability and financial stability?’ and ‘Is inflation targeting or a fixed exchange rate regime preferable for developing and emerging markets?’

Chapter 15: Monetary Policy and Inflation Modeling in a More Open Economy in South Africa

Janine Aron and John Muellbauer

Subjects: development studies, development economics, economics and finance, development economics, money and banking


Janine Aron and John Muellbauer* INTRODUCTION 15.1 South Africa (SA) in the 1990s became globally more integrated after years of isolation through trade and financial sanctions, prohibitive trade policies and a mainly closed capital account. The cessation of sanctions beginning in the early 1990s with an improved political dispensation in prospect, the gradual opening of the trade and capital accounts and the concomitant emergence of SA as a desirable emerging market destination for investors, gave impetus to a monetary policy regime change to inflation targeting from early 2000. The preceding monetary regime in the 1990s was founded on outmoded and dysfunctional monetary targeting, and was hampered by unclear policy objectives and poor policy transparency. With the opening of the economy, conflicting policy goals led to costly monetary mismanagement, hampering growth. The adoption of an inflation-targeting regime in a more open economy aimed to enhance policy transparency, accountability and predictability, and align monetary policy more closely with widespread international practice. The inflation-targeting regime (supported by fiscal policy) has successfully enhanced the credibility and effectiveness of monetary policy, achieving greater macro-stability and reducing inflation (Aron and Muellbauer, 2005, 2007a, 2008). SA’s international economic standing has consequently improved, evidenced by reduced sovereign risk spreads and improved debt ratings, while investment and growth have risen. However, changes in openness can disrupt the inflation forecasting on which targeting monetary policies depend. Since lowering import barriers typically exerts downward pressure on prices, evolving openness represents a structural break from the inflation forecasting perspective. Omitting this factor...

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