An Alternative Business Cycle Dating Procedure for South Africa

Abstract

This paper applies a factor‐augmented Markov‐switching model to the South African economy to provide an alternative classification of the business cycle and its turning points. In the principal components step, 123 variables are used to establish the aggregate cyclicality in all sectors of the economy with the number of factors chosen using a modified Bai and Ng method. By exploiting the rich nature of the dataset, we provide a model with well‐defined statistical properties that compares favourably with the South African Reserve Bank (SARB) dating points. Combining the results of the parametric approach followed in the Markov‐switching model and the non‐parametric approach followed by the SARB should allow for a robust turning point analysis. A Markov‐switching model of real gross domestic product is also estimated because this variable is commonly used in the literature and provides a benchmark for the factor models.

A Note on the (Continued) Ability of the Yield Curve to Forecast Economic Downturns in South Africa

“…3 The important finding for this paper is that five of the six alternative methods they examined for dating the business cycle reveal that 3 These methods are: gross domestic product MSIAH(3)-AR(1), diffusion MSIAH(3)-AR(2), principal component diffusion MSIA(2)-VAR(1), gross domestic product method of Bry and Boschan (1971), Bry-Boschan's (1971) diffusion approach, and an updated version of Du Plessis's (2006) BBQ method. (Bosch and Ruch, 2013). It is to this weakness in the economy that the negative yield curve at that time was correctly pointing.…”

“…It should be noted that the economic downswings identified by the SARB are not the same thing as economic recessions . Bosch and Ruch (:1) note that the SARB makes use of 186 variables and “a combination of methods” when dating turning points in the business cycle. They note, too, that while GDP growth is much slower in downswings than upswings, business cycle downswings may be periods in which average GDP growth is still marginally positive (Bosch and Ruch, ).…”

“…Bosch and Ruch () examine a variety of alternative methods for measuring turning points in the business cycle in South Africa . The important finding for this paper is that five of the six alternative methods they examined for dating the business cycle reveal that there was indeed an economic downswing in 2002‐2003 (Bosch and Ruch, ). It is to this weakness in the economy that the negative yield curve at that time was correctly pointing.…”

“…First, the fall in the long bond rate over this period which, unusually, was responsible for turning the yield curve negative, suggests that bond market participants were aware of the overall weakness of the economy and correctly anticipated that short‐term interest rates would be cut. Second, had the error not been made in calculating CPI, short‐term interest rates would almost certainly have been cut earlier and the economic weakness measured by Bosch and Ruch () may have been avoided. While the yield curve would have flattened, it may not have actually turned negative.…”

“…It is in fact forecasting official downswings in the business cycle which may include recessions, but may also not. 1978-August 1981September 1981-March 1983April 1983-June 1984July 1984-March 1986April 1986-February 1989March 1989-May 1993June 1993-November 1996December 1996-August 1999September 1999-November 2007December 2007-August 2009September 2009 Source: SARB (2013). is still marginally positive (Bosch and Ruch, 2013). Recessions, however, are generally considered as two consecutive quarters of negative GDP growth.…”