How does fiscal policy affect monetary policy in the Southern African Community (SADC)?

Fiscal policy can affect monetary policy either through debt monetisation or through a direct effect on price dynamics. The former is the conventional classical view rooted in the quantity theory of money while the latter is the modern view of the Fiscal Theory of Price Determination. Based on the dynamic response of inflation to different shocks, we test the relationship between fiscal balances and monetary stability in 10 SADC countries. Results show that five out of 10 countries considered here were characterised throughout the period 1980-2006 by fiscally dominant regimes, with weak or no response of primary surpluses to public liabilities. The remaining five countries exhibit a monetary dominant regime. The study also finds that changes in primary surpluses affect price variability via aggregate demand, suggesting that fiscal outcomes could be a direct source of inflation variability, hence, the need for policy coordination in the region.African Economic Integration, Fiscal Monetary Policy Coordination, VAR Analysis.

Dynamic Effects of Monetary Policy Shocks in Malawi

This paper sets out to investigate the process through which monetary policy affects economic activity in Malawi. Using innovation accounting in a structural vector autoregressive model, it is established that monetary authorities in Malawi employ hybrid operating procedures and pursue both price stability and high growth and employment objectives. Two operating targets of monetary policy are identified, viz., bank rate and reserve money, and it is demonstrated that the former is a more effective measure of monetary policy than the latter. The study also illustrates that bank lending, exchange rates and aggregate money supply contain important additional information in the transmission process of monetary policy shocks in Malawi. Furthermore, it is shown that the floatation of the Malawi Kwacha in February 1994 had considerable effects on the country’s monetary transmission process. In the post-1994 period, the role of exchange rates became more conspicuous than before although its impact was weakened; and the importance of aggregate money supply and bank lending in transmitting monetary policy impulses was enhanced. Overall, the monetary transmission process evolved from a weak, blurred process to a somewhat strong, less ambiguous mechanism.

Inflation Targets as Focal Points

In a world characterised by noisy information and conflicting signals, no Central Bank is always able to affect private sector expectations. Based on Morris and Shin's model, monetary policy then becomes an information game, in which individuals form their expectations based on all the information that is available to them (public and private). However individual agents also know that ultimately inflation is affected by both the objectives of the Central Bank (and hence the policies it pursues) as well as the average expectation formed by the all agents. They thus need to evaluate both actions. Central to our argument is the way that individuals interpret these actions to form their expectations. We apply Bacharach's methodology to provide a framework for assessing everyone's interpretations. Our contribution is to merge these two models to show that a monetary policy regime that has explicit quantitative objectives may provide individuals with better anchors for expectations to coordinate at. However, that is only true first, if no great shocks are anticipated to hit the economy and second, when all other public information is very unclear thus rendering the inflation target the only clear piece of information. We derive in detail the conditions under which this is true.

A Measure for Credibility: Tracking US Monetary Developments

Our objective is to identify a way of checking empirically the extent to which expectations are de-coupled from inflation, how well they might be anchored in the long run, and at what level. This methodology allows us then to identify a measure for the degree of anchorness, and as anchored expectations are associated with credibility, this will serve as a proxy for credibility. We apply this methodology to the US history of inflation since 1963 and examine how well our measure tracks the periods for which credibility is known to be either low or high. Of particular interest to the validity of the measure is the start of the Great Moderation. Following the narrative of a number of well documented incidents in this period, we check how well our measure captures both the evolution of credibility in US monetary policy, as well as reactions to inflation scares.Great Inflation, Great Moderation, Anchors for Expectations

Anchors for Inflation Expectations

We identify credible monetary policy with first, a disconnect between inflation and inflation expectations and second, the anchoring of the latter at the inflation target announced by the monetary authorities. We test empirically whether this is the case for a number of countries that have an explicit inflation target and therefore include the Euro Area. We find that for the last 10 year period, the two series are less dependent on each other and that announcing inflation targets help anchor expectations at the right level.Inflation Targets, Measures of Credibility

Testing Creative Destruction in an Opening Economy: the Case of the South African Manufacturing Industries

We study a Lucas (1978) "fruit-tree" economy under the assumption that agents are Choquet expected utility (CEU) rather than standard expected utility (EU) decision makers. The agents’ non-additive beliefs about the economy’s stochastic dividend payment process may thus express ambiguity attitudes and accommodate violations of Savage’s sure-thing principle as elicited by Ellsberg (1961). As our main formal result we establish the existence of a unique stationary equilibrium price function for the assets in this economy. In order to account for the dynamic inconsistency of CEU decision makers, we thereby use an equilibrium concept that combines the market clearing condition of general equilibrium theory with Bayesian Nash equilibrium. A simple example about the equity premium in our economy with non-additive beliefs illustrates our formal findings.

Hysteresis without Hope: investigating unemployment persistence in South Africa

This paper investigates hysteresis in South Africa's unemployment. First we test the presence of hysteresis in unemployment both by traditional stationarity tests and by us- ing non-linear transformation methods to identify two further characteristics of hysteresis, namely remanence and selective memory. In the second part of the paper we estimate a simple insider-outsider model using a Bayesian VAR methodology to identify the shocks driving the unemployment dynamics. The main �nding is that shocks to nominal wages and mark-up shocks as the main drivers of unemployment. Demand shocks do not play a dominant role. These results point to the di�culty of absorbing the current level of unemployment without signi�cant positive shocks in market structure and wage setting behaviour. The strong hysteresis present in the data shows that this excessive level of un- employment can become "equilibrium": the South African labour market presents features of the worst kind of hysteresis, a hysteresis without "hope".

Portfolio Flows in a two-country RBC model with financial intermediaries

The paper presents a two-country real business cycle model with a financial sector that intermediates portfolio flows. It is changes in demand for financial assets from foreign investors relative to domestic investors that gives rise to portfolio flows. The simulations show that portfolio flows to emerging markets respond negatively to global risk in line with findings from the empirical literature. The transmission channel that links portfolio flows to credit in emerging markets is the financial intermediary's demand for deposit liabilities (demand for savings). One can avoid the transmission by absorbing the shock before it affects the intermediary's demand for savings. The results show that financial shocks (eg: risk) can be absorbed by optimal changes in the supply of risk free assets. Real shocks (eg: income) can be absorbed by keeping the supply of financial assets fixed and instead allowing the prices to adjust to demand. Macroprudential regulation that limits the total risk exposure of the financial sector increases the volatility of portfolio flows, but reduces the volatility of consumption and labour and therefore increases welfare. Volatility in the composition of the balance sheet (portfolio flows), does not necessarily increase volatility in the aggregate size of the balance sheet (savings). The model uses a risk-constraint on bank balance sheets as a tool to ensure less-than-perfect elasticity of demand for financial assets. The elasticity of demand is important because it determines the size and direction of portfolio flows