Forecasting Monetary Policy Rules in South Africa

This paper is the first one to: (i) provide in-sample estimates of linear and nonlinear Taylor rules augmented with an indicator of financial stability for the case of South Africa, (ii) analyse the ability of linear and nonlinear monetary policy rule specifications as well as nonparametric and semiparametric models in forecasting the nominal interest rate setting that describes the South African Reserve Bank (SARB) policy decisions. Our results indicate, first, that asset prices are taken into account when setting interest rates; second, the existence of nonlinearities in the monetary policy rule; and third, forecasts constructed from combinations of all models perform particularly well and that there are gains from semiparametric models in forecasting the interest rates as the forecasting horizon lengthens.Taylor rules, nonlinearity, nonparametric, semiparametric, forecasting

The Opportunistic approach to monetary policy and financial markets

We test the concept of the Opportunistic Approach to monetary policy in South Africa post 2000 inflation targeting regime. Our findings support the two features of the opportunistic approach. First, we find that the models that include an intermediate target that reflects the recent history of inflation rather than simple inflation target improve the fit of the models. Second, the data supports the view that the South African Reserve Bank (SARB) behaves with some degree of nonresponsiveness when inflation is within the zone of discretion but react aggressively otherwise. Recursive estimates from our preferred model reveal that overall there has been a subdued reaction to inflation, output and financial conditions amidst the increased economic uncertainty of the 2007- 2009 financial crisis.monetary policy, opportunistic approach, intermediate inflation, financial conditions

Financial Market Conditions, Real Time, Nonlinearity and European Central Bank Monetary Policy: In-Sample and Out-of-Sample Assessment

We explore how the ECB sets interest rates in the context of policy reaction functions. Using both real-time and revised information, we consider linear and nonlinear policy functions in inflation, output and a measure of financial conditions. We find that amongst Taylor rule models, linear and nonlinear models are empirically indistinguishable within sample and that model specifications with real-time data provide the best description of in-sample ECB interest rate setting behavior. The 2007-2009 financial crisis witnesses a shift from inflation targeting to output stabilisation and a shift, from an asymmetric policy response to financial conditions at high inflation rates, to a more symmetric response irrespectively of the state of inflation. Finally, without imposing an a priori choice of parametric functional form, semiparametric models forecast out-of-sample better than linear and nonlinear Taylor rule models.monetary policy, nonlinearity, real time data, financial conditions

Forecasting Monetary Policy Rules in South Africa

This paper is the .rst one to: (i) provide in-sample estimates of linear and nonlinear Taylor rules augmented with an indicator of .nancial stability for the case of South Africa, (ii) analyse the ability of linear and nonlinear monetary policy rule speci.cations as well as nonparametric and semiparametric models in forecasting the nominal interest rate setting that describes the South African Reserve Bank (SARB) policy decisions. Our results indicate, .rst, that asset prices are taken into account when setting interest rates; second, the existence of nonlinearities in the monetary policy rule; and third, forecasts constructed from combinations of all models perform particularly well and that there are gains from semiparametric models in forecasting the interest rates as the forecasting horizon lengthens.

Fiscal regime changes and the sustainability of fiscal imbalance in South Africa; a smooth transition error-correction approach

In addition to the conventional linear cointegration test, this paper tests the asymmetry relationship between fiscal revenue and expenditure, by making a distinction between the adjustment of positive (budget surplus) and negative (budget deficit) deviations from equilibrium. The analysis uses quarterly data for South Africa. The paper reveals that government authorities in South Africa are more likely to react fast when the budget is in deficit than when in surplus, and that the stabilisation measures used by government are fairly neutral at low deficit levels; that is, at deficit levels of 4% of GDP and below. We conclude that an attempt to achieve fiscal sustainability via a reduction in expenditure on sectors conducive to economic growth might be prone to create social and political shocks, which could render such fiscal policy unsustainable. In South Africa the main fiscal challenge, therefore, is to find ways through which the recent gains in fiscal solvency can be consolidated.smooth transition error correction model; nonlinearity; government intertemporal budget constraint; and fiscal sustainability.

Vicious and virtuous circle: The political economy of unemployment in interwar UK and USA

This paper develops a political economy model of multiple unemployment equilibria to provide a theory of an endogenous natural rate of unemployment. This model is applied to the UK and the US interwar period which is remembered as the decade of mass unemployment. The theory here sees the natural rate and the associated path of unemployment as a reaction to shocks (mainly demand in nature) and the institutional structure of the economy. The channel through which these two forces feed on each other is a political economy process whereby voters with limited information on the natural rate react to shocks by demanding more or less social protection. The reduced form results obtained con?rm a pattern of unemployment behaviour in which unemployment moves between high and low equilibria in response to shocks

Modeling Monetary Policy In South Africa: Focus On Inflation Targeting Era Using A Simple Learning Rule

A simple empirical nonlinear framework is used to analyze monetary policy between 1983 and 2007 in South Africa, focusing on the policy of inflation targeting introduced in Feb 2000, more precisely when the South African Reserve Bank (SARB) announced that an inflation zone targeting regime of 3-6% would be in place. We find that a model specification embodying a simple ‘inflation learning rule’ for the future inflation rate seems to provide a better understanding of the decision process made by the SARB in its interest rate setting policy. The main findings are:  1) that the adoption of inflation targeting led to significant changes in monetary policy, 2) post-2000 monetary policy is asymmetric as policymakers respond more to downward deviation of inflation away from the target, 3) post-2000 policymakers may be attempting to keep inflation within the 4.5%–6.9% range rather than pursuing a target zone of 3-6%, as generally pre-announced, and 4) the response of monetary policy to inflation is nonlinear as interest rates respond more when inflation is further from the target

Nonlinear Tax Elasticities And Their Implications For The Structural Budget Balance

Research on tax elasticities in South Africa mainly employs linear models and shows that taxes evolve symmetrically irrespective of the economic cycle. This study extends this research to show that taxes behave asymmetrically and nonlinearly during expansions and contractions. Estimated linear elasticities imply that a one percent expansion in the cycle increases personal income tax, corporate income tax and value added tax by 1.43, 2.52 and 0.99 percent, respectively. However, estimated nonlinear elasticities are significantly different. During an expansion, the above elasticities increase by 1.89, 2.76 and 2.17 percent, respectively while during a contraction phase these elasticities increase by 0.89, 0.88 and 0.82 respectively. This finding of low tax collection during economic contractions has important implications for fiscal sustainability and overall fiscal prudence in South Africa. The findings of high tax elasticities during expansions might explain the underestimation of revenue by the government

Financial conditions and nonlinearities in the European Central Bank (ECB)

The purpose is to investigate how the European Central Bank (ECB) sets interest rates in the context of both linear and nonlinear policy reaction functions. It contributes to the current debate on central banks having additional objectives over and above inflation and output. Three findings emerge. First, the ECB takes financial conditions into account when setting interest rates. Second, amongst Taylor rule models, linear and nonlinear models are empirically indistinguishable within sample and model specifications with real-time data provide the best description of in-sample ECB interest rate setting behaviour. Third, the 2007-2009 financial crisis witnesses a shift from inflation targeting to output stabilisation and a shift, from an asymmetric policy response to financial conditions at high inflation rates, to a more symmetric response irrespectively of the state of inflation. Finally, guidance is provided about models to forecast interest rates in the Eurozone area. Without imposing an a priori choice of parametric functional form, semiparametric models and autoregressive processes forecast out-of-sample ECB interest rate setting behaviour better than linear and nonlinear Taylor rule models.http://www.sciencedirect.com/science/journal/0167947