Trade union inflation expectations and the second-round effect in South Africa: Toda-Yamamoto causality approach

Abstract

Inflation expectation is believed to be critical in the formation of prices and wages; hence the South African Reserve Bank (SARB) reacts to any first-round effect of inflation by tightening the monetary policy in order to avoid the second-round effect. But how important are the inflation expectations of the trade unions in leading the inflation rate? Using quarterly data and Toda-Yamamoto causality technique, this study investigates whether inflation rate is led by inflation expectations and/or vice versa, using three different measures of inflation expectations of trade union representatives. The study also investigates the importance of the exchange rate in leading or lagging inflation rate. The inflation expectations of trade union representatives were chosen because of the way in which this sector, through the trade union federation COSATU (Congress of South African Trade Unions), has antagonised the inflation-targeting framework adopted by SARB. The results obtained showed that inflation and the exchange rate have bi-directional causality, while uni-directional causality exists from inflation rate to inflation expectations. The study therefore concluded that a possible second-round effect of inflation cannot be experienced from the changes in inflation expectations of the trade unions, while providing possible policy recommendations. While many studies have observed inflation expectations in different ways, to our knowledge, no study has been conducted with regard to the cause and effect of inflation expectations of trade unions, in particular, on inflation rate using Toda-Yamamoto causality technique for South Africa.