Synchronization between South Africa and the U.S.: A Structural Dynamic Factor Analysis

Abstract

This paper studies the synchronization of economic variables between South Africa and the US. In addition it examines transmission channels through which supply and demand shocks from the US effect economic activity in South Africa. We use a structural dynamic factor model approach, instead of the well known structural vector autoregressive method, as it accommodates a large panel of time series variables. The paper contains four findings. First, using the full-sample period, US supply shocks are transmitted to South Africa through business confidence and imports of goods and services; while US demand shocks are transmitted via interest rates, stock prices, exports of goods and services, and real effective exchange rates. Second, there is a decrease in integration over time as the common component of GDP drops in the reduced sample. The impact of an increase in comovement of GDP is outweighed by several factors resulting from the structural reforms initiated by the government after the end of apartheid. Thirdly, in the latter period the South African economy is mainly affected by the US supply shocks through a variety of channels. For this latter period, US supply shocks are forcefully transmitted to South Africa via consumer and business confidence, stock prices and real effective exchange rates. Finally, the idiosyncratic component still plays an important role in the South African economy. Structural reforms are crucial to make the domestic economy competitive internationally.Dynamic factor models, international business cycles, sign restrictions