Building Institutions in Post-Conflict African Economies

institutions, reconstruction, reform

Some Issues in Modeling and Forecasting Inflation in South Africa.

Inflation targeting central banks will be hampered without good models to assist them to be forward-looking. Many current inflation models fail to forecast turning points adequately, because they miss key underlying long-run influences. The world is on the cusp of a dramatic turning point in inflation. If inflation falls rapidly, such models can underestimate the speed at which interest rates should fall, damaging growth. Our forecasting models for the new measure of producer price inflation suggest methodological lessons, and build in conflicting pressures on SA inflation from exchange rate depreciation, terms of trade shocks, collapsing oil, food and other commodity prices, and other shocks. Our US and SA forecasting models for consumer price inflation underline the methodological points, and suggest the usefulness of thinking about sectoral trends. Finally, we apply the sectoral approach to understanding the monetary policy implications of introducing a new CPI measure in SA that uses imputed rents rather than interest rates to capture housing costs.

Revised Estimates of Personal Sector Wealth for South Africa

In common with many emerging market countries, South Africa’s government does not publish balance sheet wealth estimates on a market value basis, as produced in the U.S., U.K., Japan, and elsewhere. Yet without information on the market values of liquid and illiquid personal sector wealth, it is difficult to explain aggregate consumer spending and saving, consumers’ demand for credit, and the broad money holdings of households. Behavioural equations for these variables are key components of central banks’ macro-econometric models, used in forecasting and policy-making.Understanding the domestic asset value channel of the monetary policy transmission mechanism is especially important for inflation targeting countries. We construct the first coherent set of aggregate, personal sector wealth estimates at market value for South Africa. Our quarterly estimates derive from published data on financial flows, and various other capital market data, often at book value. Our methods rely, where relevant, on accumulating flow of funds data using appropriate benchmarks, and, where necessary, converting book to market values using appropriate asset price indices. Relating asset to income ratios for various asset classes to asset price movements and rates of return, throws light on the changing composition of personal sector wealth. Most striking are the rise in pension wealth- overtaking gross housing asseta in the late 1980s; the rise in household debt; and the relative decline of liquid and housing assets, from the early and mid-1980s, respectively.

A typology of foreign exchange auction markets in sub-Saharan Africa : dynamic models for auction exchange rates

In this analytical sequel to"A Typology of Foreign Exchange Auction Markets in sub-Saharan Africa", the authors compare the micromanagement of different foreign exchange auctions in sub-Saharan Africa. Multi-unit auctions for foreign exchange were introduced in a number of countries in the 1980s and 1990s, in a transitional step toward a credible, sustainable, unified regime, such as efficient interbank market. But there is little understanding of how auction markets function in sub-Saharan Africa, and there has been virtually no research on the causes of frequent policy reversals or of auction failure. One possible cause of failure -- apart from thin markets, macroeconomic laxity, and vulnerability to terms-of-trade shocks and fluctuations in the disbursement of foreign aid -- is the inappropriate design and management of auctions. The authors estimate models for the microdeterminants of the auction rate, using weekly data on foreign exchange auctions for Ghana, Nigeria, Uganda, and Zambia. Among the policy lessons: 1) Nigeria and Zambia failed to unify and stabilize the exchange rate partly because there was no reserve price rule. When bidders learn such a rule, speculative bidding diminishes. 2) The management of a credible, sustainable reserve price policy requires an efficient secondary market. A simple underlying model, synthesized from the theoretical literature on auctions, specifies the auction rate as a function of fundamental variables and structural shift dummies. The repeated, sequential nature of these multi-unit auctions and the nonstationary nature of most of the auction variables are captured empirically by a cointegrated (error connection) framework. In addition to consistently estimating long-run and short-run parameters of auction fundamentals, the error correction model allows asymptotically efficient testing of three policy hypotheses deriving from auction theory: the competitiveness hypothesis, the effect of uncertainty on the auction-determined rate, and the revenue-equivalence hypothesis. In other words, they used these models to test the impact on the level of the auction rate of increased comptetition among bidders, of the effect of uncertainty (proxied by a volatile supply of foreign exchange), and of different pricing mechanisms.International Terrorism&Counterterrorism,Economic Theory&Research,Markets and Market Access,Access to Markets,Environmental Economics&Policies

Revised estimates of personal sector wealth for South Africa

In common with many emerging market countries, South Africa’s government does not publish balance sheet wealth estimates on a market value basis, as produced in the U.S., U.K., Japan, and elsewhere. Yet without information on the market values of liquid and illiquid personal sector wealth, it is difficult to explain aggregate consumer spending and saving, consumers’ demand for credit, and the broad money holdings of households. Behavioural equations for these variables are key components of central banks’ macro-econometric models, used in forecasting and policy-making. Understanding the domestic asset value channel of the monetary policy transmission mechanism is especially important for inflation targeting countries. We construct the first coherent set of aggregate, personal sector wealth estimates at market value for South Africa. Our quarterly estimates derive from published data on financial flows, and various other capital market data, often at book value. Our methods rely, where relevant, on accumulating flow of funds data using appropriate benchmarks, and, where necessary, converting book to market values using appropriate asset price indices. Relating asset to income ratios for various asset classes to asset price movements and rates of return, throws light on the changing composition of personal sector wealth. Most striking are the rise in pension wealth - overtaking gross housing assets in the late 1980s; the rise in household debt; and the relative decline of liquid and housing assets, from the early and mid-1980s, respectively.

Multi-sector inflation forecasting - quarterly models for South Africa.

Inflation is a far from homogeneous phenomenon, a fact often neglected in modeling consumer price inflation. Using a novel methodology grounded in theory, the ten sub-components of the consumer price index (excluding mortgage interest rates), are modeled separately and forecast, four-quartersahead. Equilibrium correction models in a rich multivariate form employ general and sectoral information, and take account of structural breaks and institutional changes. Our methods allow for longer lags than conventionally considered in VARs, but in a parsimonious manner. Sign priors are imposed on long-run effects and automatic model selection is used to select parsimonious models from more general ones. The models throw light on sectoral sources of inflation, useful to monetary policy. Data for 1979 to 2003 are used for model selection, and pseudo out of sample forecasting performance to the end of 2007 is examined. Aggregating the weighted sub-component forecasts indicates gains are made over forecasting the overall index using these methods, and also substantial gains over forecasting using benchmark naïve models. To extend this work, including sectoral information such as an explicit treatment of tax policy, regulatory information and announced administered price rises, should further enhance these forecasting methods.

Fiscal Renaissance in a Democratic South Africa

South Africa has overcome adverse initial conditions to achieve a remarkable fiscal transformation since the 1994 democratic elections, held amid uncertainty about its ability to maintain the rule of law and resist the populist spending pressures. Constitutionally-bases, durable and credible fiscal reforms have contained spending and rendered policy at all levels of government more transparent and accountable, and more predictable through multi-year budgeting. Extensive tax reform and more efficient tax collection has expanded revenue, permitting lower tax rates for both individuals and companies, and personal tax relief. Fiscal consolidation almost eliminated the budget deficit by 2005, and with improved debt management, has created a lower and more sustainable debt burden. While highly centralised revenue raising powers and greater decentralisation of expenditure to sub-national governments created a vertical fiscal imbalance, a strict no-bail out approach helped control provincial spending. The fiscal-monetary policy mix has stabilised the macro-economy and reduced uncertainty, reflected internationally in narrowed sovereign risk spreads and improved debt ratings. However, micro-service delivery in social expenditure has been disappointing (in some cases due to capacity constraints rather than inadequate fiscal allocations). And long-term decline in infrastructure investment and capital stock is only belatedly receiving attention. The challenge is to increase social and infrastructure expenditure at a sustainable rate and to improve the quality of service delivery, to avoid undermining the gains in microeconomic stability.

Financial liberalisation, consumption and debt in South Africa

South Africa experienced substantial rises in the ratios of consumption and household debt to income from 1983, for which conventional explanations in terms of income, income expectations, interest rates and wealth prove inadequate. This paper emphasizes the role of substantial financial liberalization, which is of interest for two reasons. The first is to help understand South Africa’s low saving rate, an endemic problem. The second is that unlike the UK, Scandinavia, Mexico and other countries, South Africa’s financial liberalization occurred without an asset price boom, thus illuminating the direct role of financial liberalization. Previous attempts to model financial liberalization are not fully satisfactory. Our methodological innovation is to treat financial liberalization as an unobservable, proxied by a spline function, and entering both consumption and debt equations, which are jointly estimated. We also clarify the multi-faceted effects of financial liberalization on consumption. The comprehensive solved-out consumption function uses our own constructed set of personal wealth estimates at market value and income forecasts from a forecasting equation (allowing underlying macro-fundamentals to enter the model). The empirical results corroborate the theory in the paper, confirming the importance for consumer spending of extensive financial liberalization, of fluctuations in a range of asset values and asset accumulation, and of income expectations. Results suggest that households largely pierce the corporate veil. The paper also throws important light on the monetary policy transmission mechanism in South Africa.

Housing Wealth, Credit Conditions and Consumption

There is widespread disagreement about the role of housing wealth in explaining consumption. Much of the empirical literature is marred by poor controls for the common drivers both of house prices and consumption, including income, income growth expectations, interest rates, credit supply conditions, other assets and indicators of income uncertainty (such as changes in the unemployment rate). For instance, while the easing of credit supply conditions is usually followed by a house price boom, failure to control for the direct effect of credit liberalization on consumption can over-estimate the effect of housing wealth or collateral on consumption. This paper suggests an empirical model grounded in theory with more complete controls than hitherto used. It is applied to modeling consumption in the UK and South Africa. Both countries experienced substantial credit market liberalization and rising consumption to income ratios. However, South Africa.s circumstances in the 1980s prevented an asset price boom, thus allowing the illumination of the direct role of credit liberalization. The paper incorporates methodological improvements in the measurement of credit conditions, and also clarifies the multi-faceted effects of credit liberalization on consumption.

Inflation dynamics and trade openness: with an application to South Africa

Evolving openness to trade is hard to measure, despite its relevance to models of growth, inflation and exchange rates. Our innovative technique measures trade openness encompassing both observable trade policy (tariffs and surcharges) and unobservable trade policy (quotas and other nontariff barriers), capturing the latter by a smooth non-linear stochastic trend in a model for the share of manufactured imports in home demand for manufactured goods, controlling for the business cycle and exchange rate. The evidence for South Africa suggests that increased openness has significantly reduced the mean inflation rate and has reduced the exchange rate pass-through into wholesale prices.