INTEREST RATE PASS-THROUGH IN THE COMMON MONETARY AREA OF THE SACU COUNTRIES

We investigate the interest rate pass‐through in the four Common Monetary Area (CMA) countries of the South African Customs Union (SACU). We employ an empirical pass‐through model that allows for thresholds, asymmetric adjustment, and structural changes. We show that CMA bank lending markets exhibit quite some degree of homogenization as the pass‐through is often fast and complete. Deposit markets are somewhat more heterogeneous by showing differing degrees of interest rate stickiness and asymmetric adjustment. Policy makers should therefore be concerned about imperfect competition which may be at the heart of the remaining cross‐country differences in monetary transmission in the CMA.     

ZONE‐TARGETING MONETARY POLICY PREFERENCES AND FINANCIAL MARKET CONDITIONS: A FLEXIBLE NON‐LINEAR POLICY REACTION FUNCTION OF THE SARB MONETARY POLICY

We estimate a flexible model of the monetary policy reaction function of the South African Reserve Bank based on a representation of the policymaker's preferences that capture asymmetries and zone‐targeting behaviours. We augment the analysis to allow for responses to financial market conditions over and above inflation and output stabilisation to address the current debate on the importance of financial asset prices in monetary policy decision making. The empirical results show that the monetary authorities' response to inflation is zone symmetric. Secondly, the monetary authorities' response to output is asymmetric with increased reaction during business cycle downturns relative to upturns. Thirdly, the monetary authorities pay close attention to the financial conditions index by placing an equal weight on financial market booms and recessions.     

ESTIMATING MONETARY POLICY RULES FOR SOUTH AFRICA

The paper combines the estimation of the Monetary Conditions Index (MCI) with the theoretic modelling of optimal monetary policy in South Africa. The idea that monetary policy is not only interested in optimal monetary conditions but also in external stability, provides the basis for the analysis. The paper introduces the concept of the MCI and estimates the relative influence of interest rates and exchange rates on the output gap. The estimated weights are 1.9:1. This estimation results is used to specify operating target rules for South African monetary policy.     

A Diagnostic on the West African Monetary Union

Deploying the classical optimum currency areas (OCA) theory and recent developments in the monetary literature, this paper evaluates the appropriateness of West African Monetary Union (WAEMU) as a monetary zone. Nine macroeconomic dimensions are investigated under which the first four items are quantified against a reference economy, namely the United States, the eurozone or China, while the rest are measured in absolute terms for time periods before and after the 2008‐2009 global financial crisis. Results could signify relative dominance of the three world's largest economies to the West African region. In addition to inherent asymmetries across the union, findings suggest the emerging Chinese yuan as an alternative to the euro as the monetary anchor.     

COPING WITH INFLATION AND EXCHANGE RATE SHOCKS IN THE SOUTH AFRICAN ECONOMY

Over the past ten years South Africa has moved to an increasingly open economy, characterised by a (relatively) low inflation and large and unpredictable movements in the prices of financial assets. One of these asset prices is the value of the South African currency. This volatility in the exchange rate has a direct impact on inflation. Using the interest rate as operational target, a central bank might ignore or underestimate the exchange rate transmission mechanism through which the economy is influenced. This paper proposes a Monetary Conditions Index for South Africa that can be used as a policy rule or simply as an important information variable in conducting monetary policy under an inflation‐targeting regime with a volatile exchange rate.     

LIQUIDITY CREATION IN SOUTH AFRICAN BANKS UNDER STRESSED ECONOMIC CONDITIONS

The financial crisis placed severe pressure on global bank liquidity. Many banks were unable to create sufficient liquidity and had to receive government support or face default. This paper attempts to determine the impact of the financial crisis on liquidity creation within South African banks using a model previously applied to US banks. Four measures of liquidity creation are discussed and applied to data spanning 2004‐2009. Although created, liquidity decreases steeply from 2007, liquidity levels in 2009 remain about 45% higher than those of 2004. The four large South African banks created about 80% of the total market liquidity. The authors are aware that the liquidity measures discussed in this paper may not accurately reflect the manner in which South African banks created liquidity before and during the financial crisis as the period under review was characterised by various other factors. These factors include the concurrent rise in securitisation, considerable changes in the South African Reserve Bank's (SARB) stance on monetary policy, historic low‐interest rates during the period and severe curtailing of local inter‐bank dealing. It remains possible that these factors may have had an impact on the way in which South African banks created and disseminated liquidity. This possibility will be the subject of future research.     

ON THE RAND: DETERMINANTS OF THE SOUTH AFRICAN EXCHANGE RATE

This paper is an econometric investigation of the determinants of the real value of the South African rand over the period 1984‐2007. The results show a relatively good fit. As always with exchange rate equations, there is substantial weight on the lagged exchange rate, which can be attributed to a momentum component. Nevertheless, economic fundamentals are significant and important. This is especially true of an index of the real prices of South African mineral commodities, which even drives out real income as a significant determinant. An implication is that the 2003‐2006 real appreciation of the rand can be attributed to the Dutch Disease. In other respects, the rand behaves like currencies of industrialised countries with well‐developed financial markets. In particular, high South African interest rates raise international demand for the rand and lead to real appreciation, controlling also for a forward‐looking measure of expected inflation and a measure of default risk or country risk.     

Are Determinants of Portfolio Flows Always the Same? ‐ South African Results from a Time Varying Parameter Var Model

The literature on determinants of cross‐border capital flows has consistently assumed the determinants of such flows to be constant throughout the sample. This paper investigates this notion by estimating the time varying relationship between portfolio flows to South Africa and two widely accepted determinants of such flows: the sovereign spread and global risk (measured by the CBOE Volatility Index, henceforth VIX). The results show that the time variation is highly significant and a constant parameter model will give biased estimates of the effects of risk on capital flows. The paper also gives important insights to South African policy makers and financial practitioners: Bond flows (non‐resident purchases of South African bonds) have become more sensitive to the VIX after 2010. Share flows were particularly sensitive at the peak of the 2008 global financial crisis, but have at other times not responded in a statistically significant manner to changes in global risk. The relationships are estimated using a time varying parameter vector autoregressive (TVP VAR) model with stochastic volatility.     

Spillovers of the Conventional and Unconventional Monetary Policy from the US to South Africa

This paper assesses the effect of US monetary policy on South Africa during the period 1990–2018. We separately analyse and compare the effect of conventional monetary policy, before the Global Financial Crisis, and unconventional monetary policy, after the US monetary policy reached the zero-lower bound. Our impulse response function results indicate that monetary policy in South Africa responds mainly to local inflation, economic activity and financial conditions. While there is strong correlation between the global and South African financial cycle, the financial cycle is not transmitted to the real economy because of the sluggish response of industrial production and domestic credit, especially after the global financial crisis. We see this as an indication of the effects of structural issues to the real economy and constrained households’ balance sheet which has prevented the local economy to take advantage of low local interest rates and the global economic recovery after the crisis.     

The Optimal Monetary and Macroprudential Policies for the South African Economy

We investigate the optimal design and effectiveness of monetary and macroprudential policies in promoting macroeconomic (price) and financial stability for the South African economy. We develop a New Keynesian dynamic stochastic general equilibrium model featuring a housing market, a banking sector and the role of macroprudential and monetary policies. Based on the parameter estimates from the estimation, we conduct an optimal rule analysis and an efficient policy frontier analysis, and compare the dynamics of the model under different policy regimes. We find that a policy regime that combines a standard monetary policy rule and a macroprudential policy rule delivers a more stable economic system with price and financial stability. A policy regime that combines an augmented monetary policy (policy rate reacts to financial conditions) with macroprudential policy is better at attenuating the effects of financial shocks, but at a much higher cost of price instability. Our findings suggest that monetary policy should focus solely on its primary objective of price stability and let macroprudential policy facilitate financial stability on its own.     

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.     

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.     

ASSESSING MONETARY POLICY IN SOUTH AFRICA IN A DATA‐RICH ENVIRONMENT

This paper examines the efficacy of monetary policy in the South African economy using a data‐rich framework. We use the Factor‐Augmented Vector Autoregressive (FAVAR) methodology, which contains 110 monthly variables for the period 1985:02‐2007:11. The results, based on impulse‐response functions, provide no evidence of the price puzzle observed in traditional Structural Vector Autoregressive analysis and confirm that monetary policy in South Africa is effective in stabilising prices. Unlike the traditional vector autoregressive approach, the FAVAR methodology allows further analysis of a large number of variables. Variables from real and financial variables react negatively to a contractionary monetary policy shock. Finally, we find evidence of the importance of a confidence channel transmission following a monetary policy shock.     

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.     

PRICE FLEXIBILITY IN THE COMMON MONETARY AREA

This paper examines the presence of flexibility within the common monetary area (CMA) as compared to a selected group of Southern African Development Co-operation (SADC) countries. The study tests for the readiness of SADC countries towards macroeconomic convergence and monetary unification. The methods followed examine the concept of (relative) purchasing power parity and test for the speed of adjustment of prices after a shock. The results suggest that the level of price flexibility is high within the CMA as opposed to the control group. The implication is that the CMA arrangement has managed to foster price flexibility among its member countries. Furthermore, Botswana could be a potential candidate for a monetary union with the CMA group.     

South African Exporters and the Global Crisis: Intensive Margin Shock,Extensive Margin Hangover

This paper examines how changes at the intensive (established exporters exporting existing products to established markets) and the extensive (new exporters, products or markets) margins contribute to South African export growth and how this was affected by the global financial crisis. We find that the intensive margin is the more important contributor to export growth, contributing more than three quarters of observed growth. The intensive margin contracted significantly during the global financial crisis of 2009 but bounced back to pre‐crisis levels quickly. However, the impacts on the extensive margin persisted after the crisis with lower levels of entry of firms, new products and new destinations. The short‐term impact of the crisis was mitigated by the concentration of South African exports among larger, more productive super‐exporters. However, the fall in entry of new firms, products and destinations as a result of the crisis may mean that this concentration persists, and, at least over the next few years, South Africa does not diversify and broaden its exports.     

CAPITAL CONTROLS,TWO‐TIERED EXCHANGE RATE SYSTEMS AND EXCHANGE RATE POLICY: THE SOUTH AFRICAN EXPERIENCE

South Africa's 40 years of experience with capital controls on residents and non‐residents (1961‐2001) reads like a collection of examples of perverse unanticipated effects of legislation and regulation. We show that the presence of capital controls on residents and non‐residents enabled the South African Reserve Bank to target domestic interest rates (and or the exchange rate) via interventions in the (commercial) foreign exchange market. This provides an early rationale for anchoring SA monetary policy via the exchange rate, rather than via domestic interest rates. This suggests not only that the capital controls themselves exhibited substantial institutional inertia, but that this same institutional inertia also applied to the monetary policy regime. A plausible reason for this is that for most of the 20th century in South Africa. (partial) capital controls and exchange rate based monetary policies were like Siamese twins – almost impossible to separate.     

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 CHANGING VOLATILITY OF THE SOUTH AFRICAN ECONOMY

During the last decade economic literature explored the presence of and reasons for what became known as “the great moderation” in the US and other G7 countries. “The great moderation” describes the decrease in economic volatility experienced in many of the G7 countries. This paper finds that in South Africa volatility is also not constant (it even finds that there are autoregressive conditional heteroskedastic effects present) and that volatility also decreased, particularly since 1994. Following the literature, the paper explores several reasons for this decrease and finds that smaller shocks, better monetary policy and improvements in the financial sector that place less liquidity constraints on individuals and allow them to manage their debt better are some of the main reasons for the reduction in the volatility of the South African economy. The literature on the G7 also suggests that better inventory management contributed to the lower volatility. However, this seems not to be true for South Africa.     

TRADE AND THE ENVIRONMENTAL KUZNETS CURVE: IS SOUTHERN AFRICA A POLLUTION HAVEN?

Evidence that the environmental Kuznets curve (EKC) may be explained by trade patterns casts doubt on the oft‐stated conclusion that economic growth automatically leads to environmental improvement. Trends in net exports as a proportion of consumption for both USA and UK trade with SACU were examined for various dirty industries. Some evidence of pollution haven effects is found, although a similar trend for clean industries suggests that this effect is weak. However, even a general shift in manufacturing industries from North to South (as opposed to a shift in specifically dirty industries) may explain the EKC to some extent.