Evaluating The Welfare Cost Of Inflation In A Monetary Endogenous Growth General Equilibrium Model: The Case Of South Africa

Abstract

This paper uses the general equilibrium monetary endogenous growth model of Dotsey and Ireland (1996), in which inflation distorts a variety of marginal decisions, to evaluate the welfare cost of inflation in South Africa – a country, where, since the February of 2000, the sole objective of the central bank has been to keep the inflation rate within the target band of 3 percent to 6 percent. Although individually none of the distortions is very large, they combine to yield substantial welfare cost estimates ranging between 0.70 percent of GDP to 1.33 percent of GDP for the lower and upper limits of the target band. More importantly, the welfare costs obtained here are at least three times more than those derived previously for the South African economy based on partial equilibrium approaches. These higher estimates, thus, tend to make a case for a possibly lower and narrower target band.