Charl Jooste

Fiscal Sustainability and the Fiscal Reaction Function for South Africa

How does the South African government react to changes in its debt position? In investigating the question, this paper estimates fiscal reaction functions using various methods (OLS, VAR, TAR, GMM, State-Space modelling and VECM). The paper finds that since 1946 the South African government has ran a sustainable fiscal policy, by reducing the primary deficit or increasing the surplus in response to rising debt. Looking ahead, the paper considers the use of fiscal reaction functions to forecast the debt/GDP ratio and gauging the likelihood of achieving policy goals with the aid of probabilistic simulations and fan charts.

Fiscal Policy Shocks and the Dynamics of Asset Prices: The South African Experience

This study assesses how fiscal policy affects the dynamics of asset markets, using Bayesian vector autoregressive models. We use sign restrictions to identify government revenue and government spending shocks, while controlling for generic business cycle and monetary policy shocks. In addition to examining the effects of anticipated and unanticipated revenue and spending shocks, we also analyse three types of fiscal policy scenarios: a deficit-financed spending increase, a balanced budget spending increase (financed with higher taxes), and a deficit-financed tax cut (revenue decreases but government spending stays unchanged). Using South African quarterly data from 1966:Q1 to 2011:Q2, we show that a deficit spending shock does not affect house prices, but temporarily exerts a positive effect on stock prices. With a deficit-financed tax cut shock, house prices increase persistently while stock prices increase quickly, but only temporarily. A balanced budget shock permanently decreases house prices and temporarily reduces stock prices.

Long memory, economic policy uncertainty and forecasting US inflation: a Bayesian VARFIMA approach

ABSTRACT We compare inflation forecasts of a vector autoregressive fractionally integrated moving average (VARFIMA) model against standard forecasting models. U.S. inflation forecasts improve when controlling for persistence and economic policy uncertainty (EPU). Importantly, the VARFIMA model, comprising of inflation and EPU, outperforms commonly used inflation forecast models.

Are there long-run diversification gains from the Dow Jones Islamic finance index?

We compare a nonlinear (time-varying) cointegration test with the standard cointegration test in studying the long-run relationship of the Dow Jones Islamic finance index with three other conventional global equity market indices. Our results show that there is a long-run nonlinear cointegrating relationship between the Dow Jones Islamic stock market index and other conventional stock market indices, which is not picked up by the linear cointegration test. Thus, Islamic markets seem to offer little, if any, long-run diversification to international investors.

Analyzing South Africa's inflation persistence using an ARFIMA model with Markov-switching fractional differencing parameter

The successful conduct of monetary policy relies on accurately characterising inflation’s data generating properties. Monetary policy errors that allow inflation to transition to a high inflation regime that is very persistent might have costly economic implications as the central bank attempts to bring inflation to a lower regime, say at some target level. This paper studies the duration of inflation persistence over time and across various policy regimes. We test the inertial properties of South African inflation in a Markov-Switching autoregressive fractionally integrated moving average model. We isolate period of high inflation and low inflation and analyse how persistent it is. This is an unique application to South Africa. The use of a fractional differencing ARIMA model allows for the possibility that inflation is close to a unit root, however, still mean reverting. This implies that shocks to inflation is very persistent and take long to dissipate. The inflation persistence is measured using a test by Ng and Perron (2001). We show that inflation is more persistent during high inflation episodes relative to low inflation episodes and more volatile during low inflation periods compared to high inflation periods. We estimate that it takes approximately 70 months for 50 percent of the shocks to dissipate in a high inflation regime compared to 10 months in a low inflation regime. The model identifies three structural breaks - a low inflation regime from 1920 until 1960, a high inflation regime from 1961 until 2003, and another low inflation regime over part of the inflation targeting period, 2003-2014. We also show that inflation persistence in the high inflation regime transitioned to a low inflation regime only much later than the implementation of inflation targeting - hinting that agents take time to adjust expectations. This has an important consequence for monetary policy - monetary policy errors that allow inflation to transition to a high inflation regime may take many months for any corrective policy to become effective.

Fiscal Policy Shocks and the Dynamics of Asset Prices

This study assesses how fiscal policy affects the dynamics of asset markets, using Bayesian vector autoregressive models. We use sign restrictions to identify government revenue and government spending shocks, while controlling for generic business cycle and monetary policy shocks. Using South African quarterly data from 1966: Q1 to 2011: Q2, we find that fiscal spending shocks affect stock prices more than house prices. Both spending and revenue shocks affect stock prices whereas only revenue shocks affect house prices.

A time-varying approach to analysing fiscal policy and asset prices in South Africa

This paper studies the interplay of fiscal policy and asset prices in a time varying parameter VAR. Using South African data since 1966 we are able to study the dynamic shocks of both fiscal policy and asset prices on asset prices and fiscal policy. This enables us to isolate specific periods in time to understand the size and sign of the shocks. The results seem to suggest that at least two regimes exist in which expansionary fiscal policy affected asset prices. From the 1970s until 1990 fiscal expansions were associated with declining house and slightly increased stock prices. The majority of first decade of 2000 had asset prices increasing when fiscal policy expanded. On the other hand, increasing asset prices reduced deficits for the majority of the sample period, while the recent financial crises had a marked change on the way asset prices affect fiscal policy.

The growth-inflation nexus for the U.S. from 1801 to 2013 : a semiparametric approach

We study the existence of a threshold level of inflation for the U.S. economy over 1801–2013, beyond which it has a negative effect on economic growth. A combination of nonparametric (NP) and instrumental variable semiparametric (SNP-IV) methods obtain inflation thresholds for the United States. The results suggest that the relationship between growth and inflation is hump shaped —that higher levels of inflation reduce growth more compared to low inflation or deflation. The strongest result to emerge from the study consistently shows that inflation above two per cent negatively affects growth. Two additional parametric methods confirm this finding. Another important result is that high or very low levels of inflation are undesirable and are associated with lower growth - hinting that a growth maximizing value of inflation exists.

South Africa’s economic response to monetary policy uncertainty

We study the evolution of monetary policy uncertainty and its impact on the South African economy. We show that volatility is high and constant using a stochastic volatility model in a sign-restricted VAR setup. Stochastic volatility is model driven and there is an endogenous economic response to uncertainty. Both inflation and interest rates decline in response to uncertainty. Output rebounds quickly after a contemporaneous decrease. We study the transmission mechanism of uncertainty for South Africa using a nonlinear DSGE model. The model is calibrated based on the existing literature while the persistence and size of uncertainty is taken from the empirical VAR. The DSGE model shows that the size of the uncertainty shock matters - high uncertainty can lead to a severe contraction in output, inflation and interest rates.

The dynamic response of the rand real exchange rate to fundamental shocks

Purpose - – The authors analyse the relationship between the South African real exchange rate and economic fundamentals – demand, supply and nominal shocks. The paper aims to discuss these issues. Design/methodology/approach - – The authors use a time-varying parameter VAR to study the coherence, conditional volatility and impulse responses of the exchange rate over specific periods and policy regimes. The model is identified using sign-restrictions that allow for some neutrality of impulse responses over contemporaneous and long horizons. Findings - – The results suggest that the importance of fundamental shocks on the exchange rate is time dependent. Hence there is a loss in information when using standard linear models that average out effects over time. The response of the exchange rate to demand and supply shocks have weakened over the 1994-2010 period. Research limitations/implications - – The period following financial crisis has strengthened the relationship between supply and demand shocks to the exchange rate, but has weakened the relationship between interest rate shocks and the exchange rate response. Practical implications - – This paper provides deeper insight as to how the exchange rate responds to fundamental shocks. This should help monetary policy understand the consequences of interest rate decisions on the exchange rate and the indirect effect of inflation on the exchange rate. Originality/value - – This application is new to the South African literature. The authors propose that the use of interest rates is limited in affecting the value of the rand exchange rate over particular periods. Isolating fundamental shocks to exchange rates over time helps policy makers make clearer and more informed decisions.