Research
Working papers
Trouble every day: Monetary Policy in an Open Emerging Economy
Four factors drive the high-frequency impact of monetary policy announcements in South Africa: affecting short-, mid-, and long-term yield curve, as well as country risk. Controlling for information effects, we build IVs to study the transmission of conventional monetary policy, forward guidance, term premia, country risk and information shocks. Our findings reveal textbook contractionary effects of conventional monetary policy. Policy communication, particularly forward guidance, has persistent effects on output and prices. Country risk is a novel and powerful channel of monetary policy communication in emerging markets. By defending its independence, re-stating its inflation target objective, and addressing external shocks, the central bank can mitigate country risk and generate strong expansionary effects.
The bank lending channel of monetary policy transmission in South Africa
In this paper we study the bank lending channel of monetary policy transmission in South Africa housing market. We use high-frequency policy surprises to instrument for exogenous policy shifts in a proxy-SVAR model, while we measure the supply-side changes in credit provision using data on composition of homeloan supply by banks and nonbanks. We find that the bank lending channel is operative, as banks reduce their supply of homeloans following monetary contractions with a negative effect on housing demand. We also show the effectiveness of the deposits channel: banks widen their deposit spread, and bank deposits shrink after monetary tightening. As deposits are a unique stable source of funding for banks, the deposits channel provides explanation for existence of the bank lending channel in South Africa consistent with theory.
Publications
Changing the Inflation Target in Emerging Markets: The Reward of Reducing Risk
This paper analyses the effects of change by the South African Reserve Bank (SARB) in its preferred definition of inflation target in July 2017 from a range to a point target. We estimate the implications of this shift by means of a Bayesian vector autoregression-based counterfactual exercise. Our results show that the inflation target change allowed to reduce prices and inflation expectations without negative effects on real output and employment. This was achieved via the reduction in the South African - US long-term interest rate spread (i.e. by a reduction in risk) and by a subsequent positive effect on asset prices.
Sailing into the wind: evaluating the (near) future of monetary policy in South Africa
with Tumisang Loate and Nicola Viegi. In C. Loewald and M. Stern (ed.) Unlocking growth prospects in post-pandemic South Africa. 2023. Pretoria: SARB, 11-43. WP
This paper evaluates the main challenges facing South African monetary policy. We focus on three main issues: the external environment, the growth potential of the economy and its fiscal balance. The external environment will remain uncertain and volatile and South Africa monetary policy should increase the number of tools available to deal with external volatility. Low growth puts pressure on monetary policy, but monetary policy can help in promoting growth only if there are corresponding reforms in South Africa’s labour market, investment climate and growth strategy. Finally, the fiscal balance represents the most immediate risk to the country’s macroeconomic stability but monetary policy can provide the necessary support to the economy in a context of a credible commitment to fiscal stabilisation and longterm economic reforms. Inflation targeting provides the necessary flexibility and can accommodate new instruments and monetary practices.
Policy papers
Enhancing the Quarterly Projection Model
with Jeffrey Rakgalakane, Luchelle Soobyah and Rudi Steinbach. South African Reserve Bank Working Paper, 2023. WP/23/05. WP
Over the last decade, fiscal dynamics have moved to the forefront of monetary policy deliberations. Elevated country risk premia associated with rising government debt have weighed on the exchange rate, at times fuelling imported inflationary pressures. In addition, fiscal policy actions have impacted economic activity, particularly the stimulus required during COVID-19 recession. This paper documents extensions to the South African Reserve Bank’s Quarterly Projection Model that parsimoniously capture these key channels from fiscal metrics to growth and inflation and their feedback to fiscal outcomes. The paper discusses refinements to the model’s equilibrium uncovered interest parity condition, which determines the domestic neutral real interest rate, as well as enhancements to the risk channel, labour block and drivers of inflation. It also proposes an updated specification for the Taylor rule.
The short-term costs of reducing trend inflation in South Africa
with Chris Loewald and Konstantin Makrelov. South African Reserve Bank Working Paper, 2022. WP/22/08. WP
South Africa’s inflation target remains well above the emerging market average. This imposes unnecessary costs on households, firms and economic growth. Benefits to lowering the inflation target to the emerging market average include better predictability of investment and savings returns and clearer relative price signals. The policy discussion in South Africa, however, tends to focus on the short-term transition costs of lowering inflation, while ignoring the medium- to long-run benefits of a permanently lower inflation rate. We employ two approaches to calculate the sacrifice ratio for South Africa to get a clearer view of the costs of reducing the inflation rate. The trend analysis approach developed by Ball (1994) shows that the most recent reduction in trend inflation (2016–2019) was not associated with output losses from policy setting. The structural vector autoregression approach developed by Cecchetti and Rich (2001) similarly produces a very low sacrifice ratio of just over 0.5 for the whole post-apartheid period. Using statistical methods, we further show that lower headline inflation will also reduce administrative price inflation. This can contribute to clearer relative price signals in the economy.
Bank asset portfolios, uncertainty and macroeconomy
This paper studies relationships between economic uncertainty and asset portfolio allocation by commercial banks. I obtain VAR evidence showing that positive uncertainty shock raises lending rate premium over risk-free rate and leads to reallocation of bank portfolios: issuance of business loans is reduced, while the stock of banks' safe assets increases. To account for this evidence, I propose a DSGE model that incorporates a portfolio-optimizing banking sector facing non-diversifiable credit risk, where banks' attitude to risk and expected profitability help to explain the endogenous movements of risk premium. Precautionary mechanism is in play: in addition to remunerating for risk of default on credit, premium charged by risk-averse banks provides self-insurance from expected profitability reduction. Banks reduce their exposure to credit risk by cutting down the share of risky lending in their asset portfolios and increasing the share of risk-free assets. Financial accelerator mechanism amplifies the portfolio reallocation effect of uncertainty shock, as increased external finance premium reduces entrepreneurial demand for capital, putting downward pressure on real price of capital and on borrowers' net worth, what depresses demand for capital further.
Financial frictions and robust monetary policy in the models of New Keynesian framework
In this paper I study how financial frictions affect robustness of monetary policy in DSGE models in case of model uncertainty. The types of frictions I consider are financial accelerator a la Bernanke et al. (1999) and collateral constraints as in Iacoviello (2005). Modeling monetary policy in terms of optimal interest rate rules, I find that welfare-maximizing policies for the models with financial frictions are robust to model uncertainty. Policy rule optimal for the basic New Keynesian model is not robust. Thereby I show that when there is uncertainty about what type of frictions is at work, a policymaker exposes economy to risks of significant welfare losses by using a reference model without frictions as economy representation. Using fault tolerance approach I find that modified policy rule optimal for the basic New Keynesian model is robust, when it allows responses to fluctuations in output.
Bank loan components, uncertainty and monetary transmission mechanism
I study the dynamic characteristics of bank loan components and seek to resolve the puzzle raised by den Haan et al. (2007) that commercial and industrial loans increase following monetary contraction. I estimate several structural vector autoregression models on US data for 1954-2015 and demonstrate that when risk and balance sheet factors are controlled for, business loans decrease after monetary tightening. This empirical result is consistent with bank lending channel of monetary policy transmission mechanism and addresses the question brought up by den Haan et al. (2007). I check the robustness of my finding to VAR identification scheme and to the measure of uncertainty employed. Specifically, I distinguish between volatility measures of uncertainty and measures of uncertainty as vagueness/”unknownness” of economic outlook and show that business loans go down following an uncertainty shock. The results of forecast error variance decomposition show that variance of business loans is driven by innovations to uncertainty and credit risk to the greater extent than by innovations to macroeconomic variables. This finding suggests that it is important to control for risk factors, when aiming at explaining the dynamic properties of business loans.