Bank lending, expenditure components and inflation in South Africa: assessment from bounds testing approach

Abstract

This empirical study examines the long-run relationship between inflation and its determinants in South Africa. Three models of inflation involving money supply, bank credit and expenditure components are tested using the unrestricted error correction models of Pesaran et al. (2001). Unlike other existing studies on the subject, one of the models in the present study considers various components of real income as determinants. The disaggregated components are final consumption expenditure, expenditure on investment goods and exports. Based on ‘bounds’ testing, the presence of a long-run equilibrium relationship between inflation and its determinants is confirmed for all three models. The study found that the major causes of inflation in South Africa are import prices, real income, and final consumption expenditure. The relationship is elastic for import prices and final consumption expenditure. Monetary variables, money supply and bank credit are found to have an indirect effect on inflation.