Direct vs. Indirect Impact of Fuel Price on Wages in South Africa: An Analysis Using the Impulse-Response Function

Abstract

The international oil price has been increasing significantly, but consumers react more to the announcement of the increase in fuel (pump) price, than an increase in international oil prices. This study, therefore, investigates the direct effect of fuel prices on the inflation rate and wages in South Africa, on the one hand, and the domestic price pass-through from fuel prices to wages (indirect effect) on the other. The impulse-response function of the vector autoregressive (VAR) technique was used to examine the direct effects of fuel prices on the inflation rate and wages, as well as the indirect effect from fuel prices to wages in South Africa. Quarterly data from 2001Q1 to 2018Q2 were utilised. The empirical results showed that inflation and wages responded positively to the shock in the fuel price. The results indicated that although wages increased because of a shock in the inflation rate—depicting the pass-through from the fuel price—the direct impact of the fuel price on wages is more significant. This study departs from the usual studies that examine the exchange rate pass-through of international oil prices to the inflation rate. The conclusion drawn was that the pass-through effect was not as strong and did not contribute as much as the direct effect of the fuel price. Therefore, the indirect shock of fuel prices, via inflation, does not so much cause an increase in wages as its direct shock. The study concludes with policy recommendations.