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.     

MEASURING THE WELFARE COST OF INFLATION IN SOUTH AFRICA

In this paper, we estimate the long‐run equilibrium relationship between money balance as a ratio of income and the Treasury bill rate for the period of 1965:02 to 2007:01, and in turn use the relationship to obtain welfare cost estimates of inflation. Using the Johansen technique, we estimate a log‐log specification and a semi‐log model of the above relationship. Based on the fits of the specifications, we decided to rely more on the welfare cost measure obtained under the log‐log money demand model. Our estimates suggest that the welfare cost of inflation for South Africa ranges between 0.34% and 0.67% of GDP, for a band of 3‐6% of inflation. Thus, it seems that the South African Reserve Bank's current inflation target band of 3‐6% is not too poorly designed in terms of welfare.     

CYCLICAL UNEMPLOYMENT AND CYCLICAL OUTPUT: AN ESTIMATION OF OKUN'S COEFFICIENT FOR SOUTH AFRICA

Persistently high unemployment in South Africa, especially in the face of improved economic conditions since 1994, begs the question: Does unemployment in South Africa respond to changes in output? Okun's law refers to the inverse relationship that exists between cyclical output and cyclical unemployment. This paper estimates Okun's coefficient for the South African economy, using annual data from 1970‐2005. Output and unemployment are decomposed into their trend and cyclical components, using a variety of detrending methods. The presence of structural breaks in Okun's relationship is also investigated, while cointegration analysis was also considered. Evidence of a statistically significant relationship between cyclical output and cyclical unemployment are found in both symmetric (estimates range from ?0.77 to ?0.16) and asymmetric (estimates range from ?0.77 to ?0.18) specifications of Okun's law, irrespective of the detrending technique. However, cyclical unemployment constitutes only a relatively small fraction of total (observed) unemployment, which implies that a more expansionary macroeconomic policy stance might only have a limited impact on total unemployment in South Africa.     

Re‐Examining the Role of Structural Change and Nonlinearities in a Phillips Curve Model for South Africa

Although studies generally find evidence of a Phillips curve‐type relationship in South Africa, uncertainty remains about the relevance of the model over a relatively long sample period, and whether conventional output gap measures are suitable proxies for demand pressure. This paper reviews research which shows that the Phillips curve model prevails over an extended sample, provided that the benchmark specifications include major structural changes in the balance‐of‐payments and labour market, and account for shifts in the root causes of inflation. When this is done, a linear specification with an output gap in levels correctly predicts the non‐trended inflation pattern over the period 1971(Q1)–1984(Q4), whereas a piecewise concave curve with an output gap in growth rates accurately forecasts the decelerating inflation pattern during 1986(Q1)–2001(Q2). A novel feature of the concave model is that it remains statistically robust and structurally stable when it is estimated until 2015(Q4). The concave model imparts a disinflationary bias, which suggests that monetary policy should be more expansionary during downswing phases of the business cycle and neutral during upswing phases. The analysis also considers how the shape of the Phillips curve might change if the balance‐of‐payments constraint on demand is relaxed in a significant way.     

SPATIAL BAYESIAN METHODS OF FORECASTING HOUSE PRICES IN SIX METROPOLITAN AREAS OF SOUTH AFRICA

This paper estimates Spatial Bayesian Vector Autoregressive (SBVAR) models, based on the First-Order Spatial Contiguity and the Random Walk Averaging priors, for six metropolitan areas of South Africa, using monthly data over the period of 1993:07 to 2005:06. We then forecast one- to six-months-ahead house prices over the forecast horizon of 2005:07 to 2007:06. When we compare forecasts generated from the SBVARs with those from an unrestricted Vector Autoregressive (VAR) and the Bayesian Vector Autoregressive (BVAR) models based on the Minnesota prior, we find that the spatial models tend to outperform the other models for large middle-segment houses; while the VAR and the BVAR models tend to produce lower average out-of-sample forecast errors for middle and small-middle segment houses, respectively. In addition, based on the priors used to estimate the Bayesian models, our results also suggest that prices tend to converge for both large- and middle-sized houses, but no such evidence could be obtained for the small-sized houses.     

Inflation in South Africa: An Assessment of Alternative Inflation Models

We consider the relative empirical performance of a range of inflation models for South Africa. Model coverage is of Phillips curve, New Keynesian Phillips curve, monetarist and structural models of inflation. Our core findings are that the single most robust covariate of inflation is unit labour cost. We further decompose unit labour cost into changes in the nominal wage and real labour productivity. The principal association is a strong positive relationship between inflation and nominal wages, while improvements in real labour productivity report only a relatively weak negative association with inflation. Supply‐side shocks also consistently report an association with inflation. As to demand‐side shocks, the output gap does not return a robust statistical association with inflation. Instead, it is growth in the money supply and government expenditure which return robust and theoretically consistent associations with inflationary pressure.     

DYNAMIC TIME INCONSISTENCY AND THE SOUTH AFRICAN RESERVE BANK

This paper derives the econometric restrictions imposed by the Barro and Gordon model of dynamic time inconsistency on a bivariate time-series model of consumer price index (CPI) inflation and real gross domestic product (GDP), and tests these restrictions based on quarterly data for South Africa covering the period of January 1960-April 1999, i.e. for the pre-inflation targeting period. The results show that the data are consistent with the short- and long-run implications of the theory of time-consistent monetary policy. Moreover, when the model is used to forecast one-step-ahead inflation over the period of January 2001-February 2008, i.e. the period covering the starting point of the inflation-targeting regime until date, we, on average, obtain lower rates of inflation. The result tends to suggest that the South African Reserve Bank perhaps needs to manage the inflation-targeting framework better than it has done so far.     

European Inflation and the New Keynesian Phillips Curve

The majority of macroeconomists who have studied inflation dynamics in Europe argue that the New Keynesian Phillips Curve (NKPC) provides a good way to describe changes in the price level from the 1970 on. However the vast majority of these articles estimate the NKPC using the labor income share as the proxy for real marginal cost. This article argues that the labor share cannot serve as a proxy for real marginal cost because of its countercyclicality and the lack of labor adjustment costs. Once we account for labor adjustment costs, we are able to derive a new marginal cost proxy that is indeed procyclical; however, we find that the NKPC fails to produce coefficients consistent with its underlying structural parameters when a procyclical marginal cost proxy is used. This casts serious doubt whether the NKPC is empirically applicable to Europe or, for that matter, any other country.     

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.     

AN ANALYSIS OF INVENTORY INVESTMENT IN SOUTH AFRICA

This paper describes the evolution of inventory investment in South Africa over the past two decades, and identifies the factors influencing inventory investment over this period. An econometric model of inventory investment in South Africa, based on the production smoothing approach, is constructed. The results of the model indicate that actual sales, production, unfilled orders, price levels, interest rates and expected sales have an influence on the evolution of inventory investment. These variables are directly or indirectly influenced by macroeconomic policy decisions and through their influence on inventory investment they also influence changes in gross domestic product. Therefore, prior information on the factors that influence inventory investment contributes to explaining changes in gross domestic product and may help to prepare more accurate short‐term forecasts of overall economic activity.     

FORECASTING INVESTMENT NEEDS IN SOUTH AFRICA'S ELECTRICITY AND TELECOM SECTORS

The paper uses 52‐country panel‐data for the period 1980‐2002 to estimate demand for electricity and telecom services and, based on these estimates, project investment needs in South Africa through 2010 for two growth scenarios. Projections of average annual investment needs in electricity and telecom for the current growth scenario (3.6% per annum) are of the order of 0.2% and 0.75% of GDP, respectively. An alternative, accelerated growth scenario (6% per annum) implies an approximate doubling of investment needs in these sectors.     

MODELLING INFLATION IN SOUTH AFRICA: A MULTIVARIATE COINTEGRATION ANALYSIS

We employ an expectations augmented Phillips curve framework to investigate the link between inflation, unit labour costs, the output gap, the real exchange rate and inflation expectations. Using multivariate cointegration techniques, we find evidence consistent with mark‐up behaviour of output prices over unit labour costs. Most importantly, we find that the mark‐up in the South African economy is much higher than in the U.S. For South Africa we find a markup of about 30 per cent: three times as high as the 10 per cent markup found for the U.S.     

THE IMPLICATIONS OF SOUTH AFRICAN ECONOMIC GROWTH FOR THE REST OF AFRICA

This paper measures the extent to which South African economic growth is an engine of growth in sub‐Saharan Africa. Results based on panel data estimation for 47 African countries over four decades suggest that South African growth has a substantial positive impact on growth in the rest of Africa, even after controlling for other growth determinants. The estimates are robust to the effects of global and regional shocks, changes in model specification, and sample period.     

The Impact of Health on Labour Force Participation in South Africa

This paper estimates the effect of self‐assessed health (SAH) on labour force participation (LFP) in South Africa. This is motivated by a high disease burden and declining LFP in South Africa during the study period. Data is sourced from the four waves of the National Income Dynamics Study. The results indicate a positive and significant effect of self‐reporting excellent, very good or good health on LFP (relative to fair or poor health). The effect is more pronounced for men relative to women. The result indicates that health policy can be a tool for significantly improving LFP in South Africa.     

Estimates of the Open Economy New Keynesian Phillips Curve for Euro Area Countries

This paper extends the existing literature on the open economy New Keynesian Phillips Curve by incorporating three different factors of production, domestic labor and imported as well as domestically produced intermediate goods, into a general model which nests existing closed economy and open economy models. The model is estimated for nine euro area countries and the euro area aggregate. We find that the general specification of our model improves the fit of the New Keynesian Phillips Curve considerably compared to the closed economy specification. The estimates of the structural parameters of the model suggest strong heterogeneity in the degree of price rigidity across euro area counties. Furthermore, we find the degree of price rigidity to be systematically lower in the open economy specification than in the closed economy specification and also lower than in the general specification of our model.

LONG-RUN M3 DEMAND IN SOUTH AFRICA: A COINTEGRATED VAR MODEL

This paper presents a system cointegration analysis of a long‐run demand for money (measured in terms of M3) in South Africa. In particular, the paper estimates a cointegrated vector autoregression model, consisting of real money, income and the opportunity cost of holding money. Using a variety of theory consistent identification schemes, the money demand function is identified along with other two cointegrating relations, namely, an IS‐type relationship and a relationship relating inflation to the spread between long‐ and short‐term interest rates. The model shows that of the variables used, only income and real money are error‐correcting to the money demand relation. The money demand relation is found to be relatively stable over the sample period, when short‐run fluctuations are corrected for. The model further shows that the long‐run link between money and inflation is rather weak.     

Evaluating South Africa's Open Economy

The competing theories of the macroeconomic trilemma and dilemma are empirically tested for South Africa. The empirical findings show evidence of the trilemma theory being applicable to South Africa, supporting the country's ability to maintain monetary independence (MI). An empirical puzzle, however, emerged as South Africa's MI index decreased during the country's 2000–2014 inflation‐targeting period. A possible explanation, and subject for further research, is that the increasing opening of South Africa to international flows since 1995 may have caused South Africa to be more exposed to international business cycles and shocks, resulting in a reduction in measured MI.     

INFLATION TARGETING AND THE FISHER EFFECT IN SOUTH AFRICA: AN EMPIRICAL INVESTIGATION

The paper analyses the relationship between expected inflation and nominal interest rates during a period of inflation targeting in South Africa, i.e. from 2000 to 2005. Specifically, it investigates the Fisher hypothesis that nominal interest rates move one‐to‐one with expected inflation, leaving the real interest rate unaffected. The analysis distinguishes between a short‐run Fisher effect and a long‐run Fisher effect. Using cointegration and error correction models (for monthly data for the period April 2000 to July 2005), it was found that the short‐run Fisher hypothesis did not hold during the relevant period under the inflation targeting monetary policy framework in South Africa. This is attributed to a combination of the South African Reserve Bank's (SARB) control over short‐term interest rates and the effects of the monetary transmission mechanism. The long‐run Fisher hypothesis could not be confirmed in its strictest form: while changes in inflation expectations move in the same direction as the nominal long‐term interest rate. This suggests that monetary policy has an influence on the real long‐term interest rate, which has positive implications for general economic activity, thus confirming the credibility of the inflation targeting framework.     

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.     

Measuring Core Inflation in South Africa

Measures of core inflation convey critical information about an economy. They have a direct effect on the policymaking process, particularly in inflation‐targeting countries, and are utilised in forecasting and modelling exercises. In South Africa, the price indices on which inflation is based have been subject to important structural breaks following changes to the underlying basket of goods and the methodology for constructing price indices. This paper seeks to identify a consistent measure of core inflation for South Africa using trimmed means estimates, measures that exclude changes in food and energy prices, dynamic factor models, and wavelet decompositions. After considering the forecasting ability of these measures, which provide an indication of expected second‐round inflationary effects, traditional in‐sample criteria were used for further comparative purposes. The results suggest that wavelet decompositions provide a useful measure of this critical variable.