THE CYCLICALITY OF MONETARY AND FISCAL POLICY IN SOUTH AFRICA SINCE 1994

This paper uses a structural vector‐autoregression approach to discuss the cyclicality of fiscal and monetary policy in South Africa since 1994. There is substantial South African literature on this topic, but much disagreement remains. Though not undisputed, there is growing consensus that monetary policy has contributed to the remarkable stabilisation of the South African economy over this period. The evaluation of the role of fiscal policy in stabilisation has been less favourable and there is little evidence that a countercyclical fiscal stance was a priority over this period. This paper considers these issues in an empirical framework that addresses some of the shortcomings in the literature. Specifically, it constructs a structural model in contrast with the reduced form models typically used in the South African literature, incorporates the dynamic interaction between monetary and fiscal shocks on the demand side and supply shocks on the other, and avoids controversy over “neutral” base years and the size of fiscal elasticities. The model confirms the consensus on monetary policy, finding it to have been largely countercyclical since 1994. On fiscal policy, this paper finds evidence of pro‐cyclicality, especially in the more recent period, though the policy simulations suggest that the pro‐cyclicality of fiscal policy has had little destabilising impact on real output.     

THE SOUTH AFRICAN PHILLIPS CURVE: HOW APPLICABLE IS THE GORDON MODEL?

Is there a Phillips curve relationship present in South Africa and if so, what form does it take? Traditionally the method to establish whether or not there is a relationship between the output gap and the change in inflation is merely to regress the latter on the former. This yields the well‐known augmented Phillips curve. However, Gordon has argued that this specification of the Phillips curve produces biased results. Instead, he puts forward and estimates successfully for several industrialised countries his so‐called triangular model that tests for hysteresis and inertia in the behaviour of inflation, as well as the impact on inflation of changes in the output level. This paper considers whether or not Gordon's triangle model is applicable to South Africa, i.e. are hysteresis and inertia present in South Africa? In addition, in an attempt to find a better estimation of the output gap, the paper also experiments with alternative ways to estimate the long‐run output level, including the standard HP‐filter, as well as a production function approach.     

THE REVENUE-EXPENDITURE NEXUS: HISTORICAL EVIDENCE FOR SOUTH AFRICA

Results from unit root and cointegration tests suggest that, allowing for structural breaks, government revenue and expenditure in South Africa during 1895‐2005 were I(1) series and cointegrated. Results from Granger‐type causality tests suggest that a bidirectional Granger‐causal relation existed between revenue and expenditure for the full sample period and for sub‐periods up to the 1960s, consistent with the so‐called “fiscal synchronisation hypothesis”. However, in the 1960s the causal relation appears to have shifted to run from expenditure to taxation, consistent with Peacock and Wiseman's “displacement effect”. In the context of the recent fiscal consolidation literature, the South African fiscal experience would appear to be generally consistent with either revenue‐ or expenditure‐led fiscal consolidation efforts, but with the more recent evidence favoring expenditure‐led consolidations.     

A COMPARATIVE ANALYSIS OF THE SYNCHRONISATION OF BUSINESS CYCLES FOR DEVELOPED AND DEVELOPING ECONOMIES WITH THE WORLD BUSINESS CYCLE

Globalisation brought about worldwide changes, including economic and financial integration between countries. The objective of this paper is to establish if there is synchronisation between developed and developing countries with the world cycle. Research results show that business cycles have become less volatile after globalisation, but there is not much consensus on whether business cycles have become less or more synchronised since globalisation. Little research has been done on co‐movement between emerging markets, such as South Africa, and the world business cycle. This paper derives common factors for developed and developing countries by applying principal component analysis (PCA) to output, consumption and investment data, which represents the countries' business cycles. The empirical analysis shows co‐movement between some countries and the world business cycle (G7 countries as proxy). The results suggest that there are idiosyncratic and globally common shocks, which play different roles over time in different countries. The paper goes on to suggest that there are clear differences in how developed and emerging markets co‐move with the world business cycle. A key finding is that the co‐movement between developing economies and the world business cycle has increased since globalisation. This research also confirms previous research that most economies follow the world business cycle when large shocks – such as the recent economic downturn – occur. This has implications for forecasting the business cycle, especially in times of economic turmoil.     

YAMAZAWA'S OPEN ECONOMIC ASSOCIATION: AN INDIAN OCEAN GROUPING FOR ECONOMIC COOPERATION

With the landmark economic reforms in South Asia and political changes in South Africa, several issues concerning trade and investment have emerged within the Indian Ocean region and internationally. Following the concept of “open economic association” introduced by Yamazawa, the question examined in this paper is whether a market-driven economic integration is emerging involving the Indian Ocean Rim countries.     

SHOULD SOUTH AFRICA HAVE A FISCAL RULE?

Over the past three decades many countries have struggled to find solutions to their persistent public sector deficits. For some the solution to this problem seemingly became the adoption of fiscal rules. This paper considers the applicability of one such rule, namely the output‐sensitive deficit rule of Taylor, and in particular its applicability to South Africa. The paper shows that its applicability in developing countries such as South Africa might be limited due to higher output volatility that may cause output‐sensitive deficit rules such as the Taylor rule to become more volatile. Such volatility in the deficit/GDP ratio may cause fears that government may not be able to maintain the stability of the debt/GDP ratio, thereby again introducing fiscal unsustainability. To address this problem the paper augments the Taylor rule to reduce the volatility in the public debt/GDP ratio and demonstrates how these rules would have performed in South Africa. It concludes that the augmented fiscal rule might contribute to both fiscal sustainability and economic stability in South Africa.     

Do Monetary Policy Announcements Affect Exchange Rate Returns and Volatility of Returns? Some Evidence from High‐Frequency Intra‐Day South African Data

This paper examines the temporal effect of domestic monetary policy surprises on both returns and volatility of returns of the South African rand/U.S. dollar exchange rate. The analysis in this “event study” proceeds using intra‐day minute‐by‐minute exchange rate data, repo rate data from the South African Reserve Bank's scheduled monetary policy announcements, and market consensus repo rate forecasts. A carefully selected sample over the period August 2003 to November 2017 ensures that the change in monetary policy is exogenous to the exchange rate. We find statistically and economically significant responses in intra‐day high‐frequency South African rand/U.S. dollar exchange rate returns and volatility of exchange rate returns to domestic interest rate surprises, but anticipated changes have no bearing on exchange rate returns and their volatility. The empirical results also indicate that there is an instantaneous response of the rand/dollar exchange rate to monetary policy surprises and that monetary policy news is an important determinant of the exchange rate until at least 42 minutes after the pronouncement – suggesting a high degree of market “efficiency” in its mechanical sense (although not necessarily in the deeper economic‐informational sense) in processing this information. Essentially, the asymmetric GARCH results exhibit no leverage effects – positive and negative information shocks have symmetric effects on conditional variance.     

SOUTH AFRICA'S TRANSITION TO A CONSOLIDATED BUDGET

The size of South Africa's fiscal stimuli, whether intended or not, has helped to avert negative consequences of the global financial downturn. With the economic cycle turning again, consolidation of deficits and a reduction of the level of debt are again the focus of policymakers. These outcomes are generally achieved by either increasing tax rates or cutting spending (discretionary fiscal policy), whereas an alternative option is to allow automatic stabilisers to consolidate budgets. This study attempts to answer whether cyclical factors or discretionary policy minimise output volatility and which one of the two presents a better policy option regarding uncertainty in real economic recovery. For this purpose, a small open‐economy gap model is built using South African data, where the budget deficit is endogenised by way of a fiscal policy “rule.” Sensitivity analyses and robustness checks are carried out using a structural vector autoregression. Given the estimates of both the automatic stabilisers as well as the components of discretionary fiscal policy, we are able to obtain impact multipliers on output and conduct scenario testing for optimal fiscal policy response towards fiscal consolidation as well as debt sustainability.     

Comparing Exchange Market Pressure across Five African Countries

This paper compares the credibility of exchange rate arrangements for the five African countries which are members of the Community of Portuguese Speaking Countries and will be referred to as Afro-Luso. Our working hypothesis is that credibility necessarily implies low mean exchange market pressure (EMP), low EMP conditional volatility and low-severity EMP crises under financial-market integration. In addition, economic fundamentals must account for EMP dynamics. We also seek evidence of a risk–return relationship for mean EMP and of “bad news” (negative shocks) having a greater impact on EMP volatility than “good news” (positive shocks). Using our econometric models, we are able to rank Afro-Luso countries’ conditional volatility in ordinal terms. Our main conclusion is that countries with currency pegs, such as Guinea-Bissau (GB) and Cape Verde (CV), clearly have lower volatility when compared to those with managed floats and are therefore more credible. Moreover, EMP crises episodes under pegs are much less severe. We find that economic fundamentals correctly account for mean EMP in all countries and that the risk–return relationship is much more favourable for investors under currency pegs, as the increase in volatility is lower for the same rate of return. The exception to this finding is Mozambique (MOZ), which apparently has a risk–return profile akin to that enjoyed by countries with pegs. A plausible reason is that MOZ has the only managed float in our sample implementing monetary and exchange rate policy within the confines of an IMF framework, which establishes floors for international reserves and ceilings for the central bank’s net domestic assets. This intuition needs to be tested, however. EMP conditional volatility, meanwhile, is generally driven by changes in domestic credit (lowers it) and foreign reserve changes (raises it). The first effect is more pronounced under currency pegs, but also under MOZ’s managed float. “Bad news” increases volatility more that “good news” only in the case of CV’s currency peg, which we take to be another sign of its credibility. A few striking cross-country comparisons also emerge in our analysis. Among countries with managed floats, Angola (ANG) has the most severe EMP crises, MOZ the least severe and São Tomé &; Príncipe (STP) lies between the two extremes but closer to MOZ.     

GOVERNANCE INSTITUTIONS AND PRIVATE INVESTMENT: AN APPLICATION TO THE MIDDLE EAST AND NORTH AFRICA

This paper addresses the issue of the low level of private investment in the Middle East and North Africa (MENA) region, with special emphasis on the role of governance. Based on the existing published reports, we categorize what types of governance institutions are more detrimental to entrepreneurial investments. We then estimate a simultaneous model of private investment and governance quality where economic policies concurrently explain both variables. Our empirical results show that governance plays a significant role in private investment decisions. This result is particularly true in the case of “administrative quality” in the form of control of corruption, bureaucratic quality, investment‐friendly profile of administration, law and order, as well as for “political stability.” Evidence in favor of “public accountability” is also found. Our estimations also stress that structural reforms like financial development, trade openness, and human development affect private‐investment decisions directly, and/or through their positive effect on governance.     

Market-based incentives in South Africa and Zambia: A comparative analysis of the clean development mechanism

The clean development mechanism (CDM) is intended to serve as a market-based incentive that is both efficient and cost-effective for eligible developing countries. The analysis contained in this article explores why, in theory, such an attractive incentive opportunity has been so under-utilised in sub-Saharan Africa. The paper compares the experience of the CDM in South Africa and Zambia. These two Southern African countries were selected because of their varying levels of statehood, South Africa being an emerging, middle-income economy while Zambia is classified as a least developed country. General challenges affecting the CDM were identified in the literature to be awareness, capacity, eligibility and access to finance. The paper then compares how these overarching issues specifically impact the CDM experience in South Africa and Zambia. The paper finds that common complexities relating to the CDM have varying implications for eligible host countries at different levels of statehood.     

Monetary Policy Implementation and Volatility Transmission Along the Yield Curve: The Case of Kenya

This paper analyses the degree to which volatility in interbank interest rates leads to volatility in financial instruments with longer maturities (e.g. T‐bills) in Kenya since 2012, year in which the monetary policy framework switched to a forward‐looking approach, relative to seven other inflation targeting (IT) countries (Ghana, Hungary, Poland, South Africa, Sweden, Thailand and Uganda). Kenya shows strong volatility transmission and high persistence similar to other countries in transition to a more forwardlooking monetary policy framework. These results emphasize the importance of a strong commitment to an interbank rate as an operational target and suggest that the central bank could reduce uncertainty in short‐term yields significantly by smoothing out the overnight interest rates around the policy rate.     

SYNCHRONISATION BETWEEN SOUTH AFRICA AND THE U.S.: A STRUCTURAL DYNAMIC FACTOR ANALYSIS

This paper studies the synchronisation of the South African and the US cycles and transmission channels through which supply and demand shocks from the US affect economic activity in South Africa in a structural dynamic factor model framework. We find, using the full-sample period, US supply shocks are transmitted to South Africa through business confidence and imports of goods and services; while US demand shocks are transmitted via interest rates, stock prices, exports of goods and services, and real effective exchange rates. Second, there is a decrease in integration over time translated by a drop in synchronisation of cycles. The impact of an increase in comovement of GDP is outweighed by the structural reforms initiated by the government after the end of apartheid. Finally, the idiosyncratic component still plays an important role in the South African economy.     

INFLATION IN SOUTH AFRICA: A TIME‐SERIES VIEW ACROSS SECTORS USING LONG‐RANGE DEPENDENCE

In this paper I examine the time‐series evolution of the log consumer price index series in South Africa, disaggregating the data by sectors. I examine the time period 1990m1‐2008m12, i.e. focusing on the post‐apartheid period. I used methodologies based on fractional integration using parametric and semiparametric techniques. The results indicate that the (total) inflation rate in South Africa is long memory, with an order of integration in the range (0, 0.5). The same happens with most of the data disaggregated by sectors with values of d above 1 in the log prices. Evidence of I(0) inflation is obtained in some cases for “fruits and nuts”, “vegetables” and “sugar”, and evidence of mean reversion in the log prices is only obtained in the case of “fish and other seafood”.     

FOREIGN EXCHANGE MARKET BID--ASK SPREADS AND THE MARKET PRICE OF SOCIAL UNREST

Time-series evidence yields estimates of the increase in thespread on the South African rand on days when riots, demonstrations,armed attacks, and related deaths occur in South Africa. Thecross-section evidence demonstrates how spreads vary across36 industrial and developing countries as spot rate volatilityand country risk vary. Both the changes in the spread over timefor particular countries and the changes in the spread acrossthe countries at a particular time appear to be significantlyrelated to countries' risk differences and exchange-rate volatility.     

HIGH AND VARIABLE INFLATION: FURTHER EVIDENCE ON THE FRIEDMAN HYPOTHESIS

This note, employing a GARCH model, finds a positive and significant relationship between the level and variability of inflation in South Africa in the period 1957:1‐2005:9. This provides evidence in support of Friedman's hypothesis that high inflation leads to more variable inflation.     

SOUTH AFRICA AND THE NEW PARTNERSHIP FOR AFRICA'S DEVELOPMENT: ECONOMIC SPIN-OFFS AND LINKAGES

The New Partnership for Africa's Development (NEPAD) is a concerted effort by Africa's political leaders to develop a comprehensive and integrated strategic policy framework to raise current levels of socio‐economic development and reduce high levels of poverty across the African continent. The NEPAD framework recognises the need for African countries to pool their resources together in order to enhance regional development and economic integration. To this end, NEPAD emphasises capacity building and also seeks to solicit and disburse funds towards infrastructural development programmes and poverty alleviation projects, among others. South Africa's involvement with the rest of Africa has increased significantly since 1994. Trade exports, foreign direct investment (both market and resource‐seeking in nature) and public‐private partnerships have mushroomed in many parts of the continent. Many South African firms are providing the financial impetus for the infrastructural development and rehabilitation of African economies. This paper discusses salient economic linkages between South Africa and the rest of Africa within the framework of NEPAD. South Africa is the economic hub of sub‐Saharan Africa (and indeed of the African continent), with significant agricultural, manufacturing and services capacity. South African firms have invested in the development of a number of sectors in the rest of Africa, taking advantage of the new investment incentives offered by the NEPAD framework. The target sectors range from mining, the hospitality industry, engineering and construction, finance to telecommunications. These investments and economic involvements are crucial to the development of African countries and the relevant sectors that are important for the realisation of some of the objectives of NEPAD.     

THE SENSITIVITY OF SOUTH AFRICAN INFLATION EXPECTATIONS TO SURPRISES

Price stability is widely recognised as the primary goal of modern monetary policy, and the management of private sector inflation expectations has become an essential channel through which this goal is achieved. This evaluation aims to improve the understanding of how the sensitivity of private sector inflation expectations to macroeconomic surprises in South Africa compares internationally, as this provides an indication of the contribution of monetary policy in South Africa to anchoring inflation expectations. If a central bank is credible, the financial markets should react less sensitively to macroeconomics surprises, because they trust the central bank to manage these incidents and achieve the objectives they communicated over the medium to long term. In this paper, the methodology of Gurkaynack et al. is adopted in order to measure the sensitivity of South African inflation expectations to surprises. A comparison of South Africa's results with those of countries in the original studies supports the contention that the SARB (South African Reserve Bank) has encouraged inflation expectations to be relatively insensitive to macroeconomic surprises, and offers support for the inflation-targeting framework as a means to help anchor inflation expectations.