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The purpose of this paper is to study the evolution of monetary policy uncertainty and its impact on the South African economy.

The authors use a sign restricted SVAR with an endogenous feedback of stochastic volatility to evaluate the sign and size of uncertainty shocks. The authors use a nonlinear DSGE model to gain deeper insights about the transmission mechanism of monetary policy uncertainty.

The authors show that monetary policy volatility is high and constant. Both inflation and interest rates decline in response to uncertainty. Output rebounds quickly after a contemporaneous decrease. The DSGE model shows that the size of the uncertainty shock matters – high uncertainty can lead to a severe contraction in output, inflation and interest rates.

The authors model only a few variables in the SVAR – thus missing perhaps other possible channels of shock transmission.

There is a lesson for monetary policy: monetary policy uncertainty, in isolation from general macroeconomic uncertainty, often creates unintended adverse consequences and can perpetuate a weak economic environment. The tasks of central bankers are incredibly difficult. Their models project output and inflation with relatively large uncertainty based on many shocks emanating from various sources. It matters how central bankers react to these expectations and how they communicate the underlying risks associated with setting interest rates.

This is the first study that looks into monetary policy uncertainty into South Africa using a stochastic volatility model and a nonlinear DSGE model. The results should be very useful for the Central Bank as it highlights how uncertainty, that they create, can have adverse economic consequences.

This paper aims to study the interplay of fiscal policy and asset prices in a time-varying fashion.

Using South African data since 1966, the authors are able to study the dynamic shocks of both fiscal policy and asset prices on asset prices and fiscal policy based on a time-varying parameter vector autoregressive (TVP-VAR) model. This enables the authors to isolate specific periods in time to understand the size and sign of the shocks.

The results seem to suggest that at least two regimes exist in which expansionary fiscal policy affected asset prices. From the 1970s until 1990, fiscal expansions were associated with declining house and slightly increased stock prices. The majority of the first decade of 2000 had asset prices increasing when fiscal policy expanded. On the other hand, increasing asset prices reduced deficits for the majority of the sample period, while the recent financial crises had a marked change on the way asset prices affect fiscal policy.

This is the first attempt in the literature of fiscal policy and asset prices to use a TVP-VAR model to not only analyse the impact of fiscal policy on asset prices, but also the feedback from asset prices to fiscal policy over time.

The authors analyse the relationship between the South African real exchange rate and economic fundamentals – demand, supply and nominal shocks. The paper aims to discuss these issues.

The authors use a time-varying parameter VAR to study the coherence, conditional volatility and impulse responses of the exchange rate over specific periods and policy regimes. The model is identified using sign-restrictions that allow for some neutrality of impulse responses over contemporaneous and long horizons.

The results suggest that the importance of fundamental shocks on the exchange rate is time dependent. Hence there is a loss in information when using standard linear models that average out effects over time. The response of the exchange rate to demand and supply shocks have weakened over the 1994-2010 period.

The period following financial crisis has strengthened the relationship between supply and demand shocks to the exchange rate, but has weakened the relationship between interest rate shocks and the exchange rate response.

This paper provides deeper insight as to how the exchange rate responds to fundamental shocks. This should help monetary policy understand the consequences of interest rate decisions on the exchange rate and the indirect effect of inflation on the exchange rate.

This application is new to the South African literature. The authors propose that the use of interest rates is limited in affecting the value of the rand exchange rate over particular periods. Isolating fundamental shocks to exchange rates over time helps policy makers make clearer and more informed decisions.