This paper empirically investigates the reaction of inflation to macro-economic shocks using the Vector Error Correction modelling approach (VECM) with monthly data from 2009:01 to 2012:12. The Zimbabwean economy was dollarised during this period, after having abandoned its own currency in 2009, following the hyperinflation episode of 2007-2008. The empirical findings show that the reaction of price formation in Zimbabwe to external shocks, such as the appreciation or depreciation of the South African rand against the US dollar and the increase in international food and oil prices is immediate with permanent effects. Specifically, the study found that an appreciation of the South African rand against the US dollar, results in a sharp increase in inflation during the first 6 months and the effects are permanent. Similarly, a positive shock to international oil prices also results in a sharp increase in inflation, during the first 6 months, remaining high over the forest period. The impact of a positive shock to food prices, is however, transitory, only felt during the first 4 months, before declining during the next 4 months and remaining at a moderately high level over the forecast period. The policy implication from this analysis is a need for Zimbabwean authorities to put in place measures to mitigate the negative impact of external shocks on inflation, given that the country lost its monetary policy autonomy when it dollarised in 2009.
The Reaction of Inflation to Macroeconomic Shocks: The Case of Zimbabwe (2009 – 2012)
Working paper 707
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