Long-term interest rates have two major drivers: expectations of future short term interest rates and the term premium. We show that the term premium embedded in South African long rates has risen over the last year and is significantly higher than in advanced economies like the United States. Our modelling results suggest that a higher term premium tends to have adverse impacts on domestic activity and the currency. Higher short rate expectations, on the other hand, tend to have the opposite effect on the economic slack, consistent with such expectations being informative about the outlook for domestic growth and inflation.
Author: Konstantin Makrelov, Rob Davies and Laurence Harris
South Africa’s economy has a very well-developed financial sector and high reliance on capital flows. We employ a micro-founded and stock- and flow-consistent model in the tradition of Backus et al. (1980) to study the impact of capital flow reversal shocks on the South African economy. The model provides for a richer representation of institutional balance sheets than existing models do. The financial sector’s behaviour in the model draws on the recent theoretical frameworks of Borio and Zhu (2012) and Woodford (2010), which highlight the relationship between bank capital, the risk-taking behaviour of the financial sector, lending spreads and economic activity. We specify a dynamic adjustment model of household expectations with properties that differ from the way in which expectations are formed in both stock- and flow-consistent as well as dynamic stochastic general equilibrium (DSGE) models. Household expectations resemble bounded rationality. The financial accelerator mechanism operates through the balance sheets of all institutions in the economy. The results indicate larger impacts compared to previous studies. We find that, even in the absence of large foreign currency-denominated liabilities, a reversal in capital flows can affect the domestic economy through its impact on domestic liquidity, on the risk-taking behaviour of the financial sector, and on the demand for assets. The negative effect can be exacerbated if the shock changes the expectation formation process of agents.
This paper investigates the aggregate and sectoral public-private remuneration pattern in South Africa from 2001:q1 to 2017:q1. Co-integration analysis confirm a stable, long-run relationship. The adjustment to the deviations from this long-run relationship is strong and significant for public-sector remuneration, while private-sector earnings neither respond to the deviations from the long-run relationship nor lagged changes of public sector remuneration. No individual public-sector remuneration is found to Granger-cause an individual private-sector remuneration. On the other hand, causal relations between private-sector remuneration and public sector remuneration cannot be rejected. A traditional “Dutch-disease” hypothesis for South Africa is rejected. Widening this analysis to individual private and public sectors confirms the results with aggregate earnings with two exceptions: 1) Earnings in financial intermediation and private road transport can be better explained including public sector earnings, and 2) Earnings in manufacturing and mining are found to be related to public sector earnings in the long run. Nevertheless, the degree of fit is low for individual private sector variables except financial intermediation and private road transport while it is high for individual public sector earnings except local authorities. Efforts to slow down the speed of the wage-price spiral should not exclude the private sector.
This paper investigates the impact of rand shocks on industry output and various other South African macroeconomic variables. We use a factor augmented model, which has the key advantage of providing a rich narrative about the disaggregated impacts of exchange rate shocks. We show that the currency tends to react to changes in the relative fundamentals of the economy, such as those captured by commodity export prices, and that the independent impact on the economy of exchange rate changes that are unrelated to fundamentals is estimated to be small. The results suggest that the exchange rate tends to act as a shock absorber to the shocks that hit the economy; a large proportion of the variation in the rand can be explained by other shocks, while rand shocks themselves explain a relatively small proportion of South Africa’s macroeconomic volatility. That said, the role that the exchange rate plays as a shock absorber appears to be weaker in South Africa than for other commodity exporters like Australia and New Zealand.
Author: Lauren Kuhn, Franz Ruch, and Rudi Steinbach
The global financial crisis (GFC) saw real interest rates fall to all-time lows as central banks aimed to stimulate economic activity. The effectiveness of such low real rates depends, to a large extent, on the neutral real interest rate — popularly referred to as r-star. Monetary policy is considered expansionary when real interest rates are below r-star, and vice versa. However, the challenge arises from the fact that r-star is unobservable. This paper estimates r-star in the spirit of the popular Laubach-Williams (LW) methodology, but adapts their approach to capture the dynamics of a small open economy. This is achieved by incorporating additional drivers of the neutral rate, such as domestic net savings and investment, South Africa’s country risk premium, and the potential growth rate of our trading partners. In addition, foreign linkages like the exchange rate and international commodity prices are included to capture the impact of developments in the rest of the world on South African growth and inflation. The results suggest that South Africa’s r-star has fallen less than in advanced economies — from an average of 4.4 per cent from 2000 to 2006 to 1.9 per cent in 2017Q4.
Author: Jenny Kilp, Vafa Anvari, Samantha Springfield and Crystal Roberts
Following the 2007/08 global financial crisis, it became evident that there was a need for a strengthening of the global financial safety net (GFSN). However, the manner in which this should be achieved became a polarising issue of debate in international institutions such as the International Monetary Fund (IMF) and the G20. The empirical evidence concerning the impact of the GFSN remains scarce, therefore, this paper seeks to contribute to the debate by investigating the potential impacts that the various layers of the GFSN can have on sovereign borrowing costs in emerging markets. After initially replicating common methodologies in the literature concerned with identifying determinants of foreign currency sovereign spreads in emerging markets, the analysis is expanded to include elements of the GFSN. The results indicate that whilst the liquidity buffers provided by the overall GFSN appear to lower sovereign spreads, the impact of individual layers of the safety net are more ambiguous.
Author: Byron Botha, Franz Ruch, and Rudi Steinbach
Potential growth, or the non-inflationary rate of growth in output, is generally viewed as a slow-moving and smooth process. This implies that all the sudden changes in real gross domestic product (GDP), regardless of origin, are reflected in the output gap. There are, however, short-lived supply shocks. Recent examples include the platinum-sector strike of 2014 and the drought of 2015/16 that are more accurately identified as temporary shifts in potential growth. We update the South African Reserve Bank’s current, finance-neutral, estimates of potential growth to account for these short-lived supply shocks. We compare the supply shocks, that should shift potential growth rather than the output gap generated from the model, to a structural vector autoregression (SVAR) model. The resulting output gap more accurately reflects a measure of demand pressures in the economy at any given point in time. The output gap is not as wide as previously estimated after 2015.
This paper investigates the public-private remuneration pattern in South Africa since the introduction of an inflation-targeting framework in 2000. Co-integration tests and analysis confirm that there is a stable, long-run relationship between nominal and real remuneration in the public and private sector. The adjustment to the deviations from this long-run relationship is strong and significant for public-sector remuneration, while private-sector wages neither respond to the deviations from the long-run relationship nor lagged changes of public sector remuneration. The causal direction from private- to public-sector remuneration does not change if real earnings are calculated with the gross domestic product (GDP) deflator. This is confirmed by simple Granger causality tests. If this pattern remains stable, efforts to slow down the speed of the wage-price spiral should not exclude the private sector.
Author: Aadila Hoosain, Alta Joubert and Alain Kabundi
This paper uses the microstructure approach for the South African foreign exchange market to determine the impact of order flow on the rand/US dollar exchange rate over the short and long term. A hybrid model which combines microeconomic and macroeconomic fundamental determinants of the exchange rate has been adopted. The analysis uses monthly series from January 2004 to December 2016 and finds that order flow explains movements in the exchange rate, both in the short and in the long term. The speed of adjustment from short-term deviations is relatively slow. The results based on the rolling-window estimation of the long-run model provide evidence of a changing relationship between order flow and the exchange rate. Consistent with the literature, the results show that the rand/dollar exchange rate reacts to fundamental variables only in the long term. Unlike Meese and Rogoff (1983), who postulate that the best way to estimate the exchange rate over the short term is with a random walk model, the current study shows that the microstructure approach can be exploited to explain short-term dynamics in the exchange rate.
Author: Byron Botha, Shaun de Jager, Franz Ruch and Rudi Steinbach
The macroeconomic modelling and forecasting process at the South African Reserve Bank makes use of a suite of models. This paper provides an update of the Quarterly Projection Model (QPM) – a so-called gap model – which has played an integral role in the suite since 2007. Details of the structure and functioning of the QPM model, with particular focus on the four most important gaps – the output gap, real exchange rate gap, real interest rate gap, and inflation gap (or inflation from target) – are provided. The model is then used to decompose these four gaps in order to tell a coherent story of South Africa’s macroeconomic dynamics since the inception of inflation targeting. From the perspective of the policy maker, the QPM provides a tool that quantifies the consequences of its actions on the economy, while adequately highlighting the trade-offs that are faced in the process.