Effects of South African Monetary Policy Implementation on the CMA A PVAR Approach

31 January 2017
Publication Type: Policy Brief
JEL Code: E52, E6, F58

South Africa (SA) through its central bank, the South African Reserve Bank (SARB), adopted the IT monetary policy framework in February 2000. The IT framework in SA is based on inflation expectations and hence it is forward looking in the sense that a specific target for inflation has to be met within a predetermined time. Over the past decades, the other countries in the Common Monetary Area (CMA) have harmonised their monetary and exchange rate policies. Lesotho, Namibia and Swaziland (LNS) countries have pegged their respective national currencies to the South African rand, and as long as SA pursues a price stability objective, the impact will be transmitted to these countries and their economies will be affected. The CMA arrangement has therefore prevented the LNS countries from exercising discretionary monetary policies. This framework is in practice a de facto monetary policy framework for the CMA as a whole. Needless to say, the CMA arrangement resembles an asymmetric monetary union, with bigger country, SA, responsible for monetary policy formulation and implementation.

The SA repo rate has direct effects on other variables in the South African economy, such as other interest rates, the exchange rate, money and credit, other assets prices and decision on spending and investment (Smal and Jager, 2001). Due to the close economic and financial linkages between SA and the LNS countries, the effects of monetary policy implementation in SA may have implications for the LNS countries. Therefore, the monetary policy stance in SA may have spill-over effects onto the rest of the CMA neighbouring economies such as Lesotho. This study therefore looks at the effects of SA’s monetary policy implementation on key macroeconomic variables in the rest of the CMA.

Key Results

The findings reveal that the South African repo rate has more impact on lending rates in the entire CMA region, accounting for about 63.8 per cent and 63.0 per cent of its short-run and long-run variance, respectively. This is then followed by the impact on inflation and private sector credit in the region, at about 24 per cent and 18 per cent, respectively both in the short-run and long-run. Furthermore, the South African repo rate has a marginal impact on interest rate spread, broad money supply and economic growth in the CMA, accounting for about 0.6 per cent, 1.0 per cent and 7.6 per cent, respectively of its short-run and long-run variance.

The impulse-response functions depicts that, a 10 per cent increase in South African repo rate leads to about 0.6 per cent increase in the lending rates in the rest of the CMA region for up to five periods, after which it becomes statistically insignificant.  Furthermore, the response of inflation in the CMA to a shock in SA repo rate is also positive and statistically significant for up to about four periods. This is in line with the findings by Smal and Jager (2001) that the lag varies between one and two years, but with rapid financial market innovations and globalization, this lag may differ. It may be iterated that there are long lags in the transmission mechanism (i.e. between a change in the monetary policy stance and the rate of inflation) and it is important to note that these lags differ from country-to-country and also within the same country from time-to-time (Smal and Jager, 2001). The response of economic growth in the CMA region to a positive shock in SA repo rate is positive and statistically significant for one year only, after which it becomes insignificant. The interest rate spread, private sector credit extension and broad money supply seem not to respond to shock in the South African repo rate.

Policy Implications

LNS countries should always brace for negative or positive spill-over effects accruing from the monetary policy stance by the bigger country – SA, since monetary policy decisions in the CMA are to a larger extent formulated and implemented solely by the South African Reserve Bank under the CMA agreement.

Therefore because of the economic and financial linkages between SA and LNS countries, the latter have to ensure that their key interest rates and inflation rates, among others, are in line with SA’s rates so as to maintain the one-to-one parity between their respective currencies and the South African Rand. Hence the SA monetary policy implementation has direct impact on key macroeconomic variables in the rest of the CMA.

Series title: Research Brief 100
1 January 2017
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