Monetary policy or fiscal policy, which one better explains inflation dynamics in South Africa?: research

South African monetary authority focuses on maintaining stable inflation rates. However, monetary policy needs to go hand-in-hand with other policies in order to ensure stable inflation and economic growth. The motivation for the study stems from the ongoing debate over whether monetary or fiscal policy is important in determining inflation in South Africa. The unique contribution of this study is the inclusion of the Fiscal Theory of the Price Level (FTPL) in the augmented Gordon‘s model, which no known study to the author has attempted and thereby investigating whether fiscal side is imperative in determining the changes in inflation, alongside the current monetary policies. This study investigated the applicability of the fiscal policy, along with monetary and structural factors, in the inflation rate process using the vector error correction model (VECM). Results showed that changes in inflation rate are as a result of changes in output growth, government deficit, electricity price and exchange rate and that the fiscal factors, among other variables, contribute more to inflation dynamics in South Africa, thus emphasising the importance of fiscal policies in controlling inflation.