Drivers of Inflation in South Africa Before and After the COVID‐19 Pandemic

Abstract

ABSTRACTThis paper examines the drivers of consumer price inflation in South Africa to understand their changing pattern before and after the COVID‐19 pandemic. Using quarterly data from 1999Q1 to 2023Q4 and employing a Bayesian VAR model with a penalty function to identify various shocks that drive inflation, we find dominant and persistent role for domestic shocks in explaining inflation fluctuations in South Africa, both before and after COVID‐19 pandemic. In the pre‐pandemic era, domestic shocks accounted for 78% of the positive historical deviation of inflation from its mean, predominantly driven by total domestic demand shocks (44%) with domestic supply shock contributing about 34% to positive inflation variation. Whereas, in the post‐COVID era, domestic shocks still played a dominant role, contributing about 65% to inflation increase, but the relative contribution of total domestic demand increased to three times as large as domestic supply shock. More importantly, the relative contribution of global shocks increased from 22% in the pre‐COVID era to 35% in the post‐COVID era, primarily driven by the growing influence of global supply shocks. Our results suggest that South African inflation increases are largely demand driven and hence within the remit of the South African Reserve Bank to actively use its policy tools to stabilize price level.