A macroeconometric policy model of the South African economy based on weak rational expectations with an application to monetary policy

Bauknecht, Klaus Dieter (2000)

Dissertation (PhD) -- University of Stellenbosch, 2000.


ENGLISH ABSTRACT: The Lucas critique states that if expectations are not explicitly dealt with, conventional econometric models are inappropriate for policy analyses, as their coefficients are not policy invariant. The inclusion of rational expectations in ·conventional model building has been the most common response to this critique. The concept of rational expectations has received several interpretations. In numerous studies, these expectations are associated with model consistent expectations in the sense that expectations and model solutions are identical. To derive a solution, these models require unique algorithms and assumptions regarding their terminal state, in particular when forward-looking expectations are present. An alternative that avoids these issues is the concept of weak rational expectations, which emphasises that expectation errors should not be systematic. Expectations are therefore formed on the basis of an underlying structure, but full knowledge of the model is not essential. The accommodation of this type of rational expectations is accomplished by means of an explicit specification of an expectations equation consistent with the macro econometric model's broad structure. The estimation of coefficients relating to expectations is achieved through an Instrumental Variable approach. In South Africa, monetary policy has been consistent and transparent in line with the recommendations of the De Kock Commission. This allows the modelling of the policy instrument of the South African Reserve Bank, i.e. the Bank rate, by means of a policy reaction function. Given this transparency in monetary policy, the accommodation of expectations of the Bank rate is essential in modelling the full impact of monetary policy and in avoiding the Lucas critique. This is accomplished through weak rational expectations, based on the reaction function of the Reserve Bank. The accommodation of expectations of a policy instrument also allows the modelling of anticipated and unanticipated policies as alternative assumptions regarding the expectations process can be made during simulations. Conventional econometric models emphasise the demand side of the economy, with equations focusing on private consumption, investment, exports and imports and possibly changes in inventories. In this study, particular emphasis in the model specification is also placed on the impact of monetary policy on government debt and debt servicing costs. Other dimensions of the model include the modelling of the money supply and balance of payments, short- and long-term interest rates, domestic prices, the exchange rate, the wage rate and employment as well as weakly rational expectations of inflation and the Bank rate. The model has been specified and estimated by usmg concepts such as cointegration and Error Correction modelling. Numerous tests, including the assessment of the Root Mean Square Percentage Error, have been employed to test the adequacy of the model. Similarly, tests are carried out to ensure weak rational expectations. Numerous simulations are carried out with the model and the results are compared to relevant alternative studies. The simulation results show that the reduction of inflation by means of only monetary policy could impose severe costs on the economy in terms of real sector volatility.

AFRIKAANSE OPSOMMING: Die Lucas-kritiek beweer dat konvensionele ekonometriese modelle nie gebruik kan word vir beleidsontleding nie, aangesien dit nie voorsiening maak vir die verandering in verwagtings wanneer beleidsaanpassings gemaak word nie. Die insluiting van rasionele verwagtinge in konvensionele ekonometriese modelle is die mees algemene reaksie op die Lukas-kritiek. Ten einde die praktiese insluiting van rasionele verwagtings III ekonometriese modelbou te vergemaklik, word in hierdie studie gebruik gemaak van sogenaamde "swak rasionele verwagtings", wat slegs vereis dat verwagtingsfoute me sistematies moet wees nie. Die beraming van die koëffisiënte van die verwagtingsveranderlikes word gedoen met behulp van die Instrumentele Veranderlikes-benadering. Monetêre beleid in Suid-Afrika was histories konsekwent en deursigtig in ooreenstemming met die aanbevelings van die De Kock Kommissie. Die beleidsinstrument van die Suid-Afrikaanse Reserwebank, naamlik die Bankkoers, kan gevolglik gemodelleer word met behulp van 'n beleidsreaksie-funksie. Ten einde die Lukas-kritiek te akkommodeer, moet verwagtings oor die Bankkoers egter ingesluit word wanneer die volle impak van monetêre beleid gemodelleer word. Dit word vermag met die insluiting van swak rasionele verwagtings, gebaseer op die reaksie-funksie van die Reserwebank. Sodoende kan die impak van verwagte en onverwagte beleidsaanpassings gesimuleer word. Konvensionele ekonometriese modelle beklemtoon die vraagkant van die ekonomie, met vergelykings vir verbruik, investering, invoere, uitvoere en moontlik die verandering in voorrade. In hierdie studie word daar ook klem geplaas op die impak van monetêre beleid op staatskuld en die koste van staatsskuld. Ander aspekte wat gemodelleer word, is die geldvoorraad en betalingsbalans, korttermyn- en langtermynrentekoerse, binnelandse pryse, die wisselkoers, loonkoerse en indiensneming, asook swak rasionele verwagtings van inflasie en die Bankkkoers. Die model is gespesifiseer en beraam met behulp van ko-integrasie en die gebruik van lang-en korttermynvergelykings. Die gebruiklike toetse is uitgevoer om die toereikendheid van die model te toets. Verskeie simulasies is uitgevoer met die model en die resultate is vergelyk met ander relevante studies. Die gevolgtrekking word gemaak dat die verlaging van inflasie deur alleenlik gebruik te maak van monetêre beleid 'n swaar las op die ekonomie kan lê in terme van volatiliteit in die reële sektor.

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