Person:

Sturzenegger, Federico

This paper uses an SVAR approach to discuss the cyclicality of fiscal and monetary policy in South Africa since 1994. There is substantial South African literature on this topic, but much disagreement remains. Though not undisputed, there is growing consensus that monetary policy has contributed to the remarkable stabilization of the South African economy over this period. The evaluation of the role of fiscal policy in stabilization has been less favorable and there is little evidence that a countercyclical fiscal stance was a priority over this period. This paper considers these issues in an empirical framework that addresses some of the shortcomings in the literature. Specifically, it constructs a structural model in contrast with the reduced form models typically used in the South African literature, incorporates the dynamic interaction between monetary and fiscal shocks on the demand side and supply shocks on the other, and avoids controversy over ‘neutral’ base years and the size of fiscal elasticities. The model confirms the consensus on monetary policy, finding it to have been largely countercyclical since 1994. On fiscal policy, this paper finds evidence of pro-cyclicality, especially in the more recent period, though the policy simulations suggest that the pro-cyclicality of fiscal policy has had little destabilizing impact on real output.

This paper uses a structural VAR methodology to identify aggregate demand and supply shocks to real output for the South African economy. Demand shocks, in turn, are separated into fiscal and monetary shocks. The model is estimated with quarterly data over two overlapping samples: 1960Q2 - 2006Q4 and 1983Q4 - 2006Q4. The identified (structural) shocks were used in a historical decomposition to split output into a measure of potential output (resulting from the evolution of supply shocks) and a measure of the business cycle (the gap between actual and potential output). This measure of potential output suggests a significant decline relative to trend in the years prior to the political transition of 1994 and a swift reversal thereafter. The paper presents evidence from three sources to support its identification of aggregate supply and demand shocks. These sources are the following: theory consistent impulse response functions; a close match between the implied measure of the business cycle and independent information about the South African business cycle; and a demonstration of the close match between the identified series of aggregate supply shocks and important historical events in the decades prior to and following 1994 that have been identified by economic historians as important shocks to the South African economy.