International Fisher Effect and Purchasing Power Parity: The case of the South African Rand and US Dollar

Abstract

This study aims to investigate the presence of the International Fisher Effect (IFE) and Purchasing Power Parity (PPP) in the case of the South Africa Rand (ZAR) and the United States Dollar (USD) using monthly data that span from January 2014 to December 2019. The study adopted an ordinary least square (OLS) model and the Granger causality econometric technique to achieve the stated objectives. Based on the IFE and PPP assumptions, the OLS results indicate an insignificant positive relationship between the inflation differentials in South Africa and the United States of America. The model revealed that a 1% increase in the inflation differential between the two countries will trigger an increase in the South African interest rate which will furthermore cause an appreciation of the exchange rate in the long run. The model revealed the presence of the IFE and PPP between the ZAR and the USD. The pass-through effect of the IFE and PPP adjustment is incomplete in the analysis due to the peculiarities of the South African economy (reliance on community and its volatile effect on the country’s foreign earnings, corruption, civil unrest, concern around political instability, etc.). In light of the above, the study recommended policy measures that focus on diversifying the foreign earning source of the country and policies that enhance the level of political stability in the country to further increase the level of confidence foreign investors have in the stability and monetary policy of the country