Testing the Validity of the Quantity Theory of Money on Sectoral Data: Non-Linear Evidence from South Africa

Purpose: The purpose of this study is to test the validity of the quantity theory of money (QTM) on South African sectoral data. The rationale of this study and its necessity for South Africa as the case study is that, although aggregate inflation may lie within the target range, inflation at a sectoral level, particularly in the food and transport sector, is still a matter of concern in South Africa. Methodology/approach: This study employed the Non-linear Autoregressive Distributed Lagged model (NARDL) to assess potential asymmetries in the effect of money supply to differentiate between the effects of contractional and expansional episodes on inflation at the sectoral level. Quarterly time series data spanning from 2002Q2 to 2021Q2 was utilised for the estimation. Ultimately, the causal effect amongst the variables is examined by employing the Pairwise Granger Causality test. Findings: The results suggest that in the short run, the effect of monetary policy shocks is very weak. On the other hand, in the long run, both negative and positive shocks in the money supply push inflation at the sectoral level in the opposite directions, and positive shocks (expansionary monetary policy) have a greater effect than negative shocks, which renders the QTM invalid in South Africa. The sectoral response was found to be heterogeneous in the long run, and this was also backed by the results of the Granger Causality test and the dynamic multipliers. Asymmetry in the effect of the money supply is assessed in some of the sectors only in the long run. Practical implications: Based on the results, this study confirms great discrepancies in sectoral responses. Therefore, aggregate inflation may not be a good indicator of the inflation path in South Africa, as it may underestimate sectoral variations. Originality/value: The originality of this study lies on testing the validity of the QTM on inflation at the sectoral level in the South African context using a non-linear approach to assess potential asymmetry between the effects of expansionary and contractionary episodes of monetary policy shocks.