Abstract In this paper an open economy New Keynesian model of the South African economy is presented. The model is constructed to provide for incomplete pass-through of exchange rate changes, external habit formation, partial indexation of domestic prices and wages to past inflation, and staggered price and wage setting. Furthermore, the model is estimated using Bayesian techniques on South African domestic and trade partner data for the period 1990Q1 to 2007Q4. The estimated model is analysed by means of impulse response functions and its forecasting performance is compared with that of the Reuters consensus forecasts of the relevant South African variables.