The Role of the Exchange Rate in a New Keynesian Dsge Model for the South African Economy

Abstract

We build a small open economy New Keynesian dynamic stochastic general equilibrium model for South Africa similar to Steinbach "et al". We abandon their assumption of complete risk sharing with the foreign economy, and introduce country risk shocks to allow deviations from uncovered interest rate parity. These changes allow us to include the exchange rate as an observable variable in the estimation of the model. Using forecast error variance decompositions and historical decompositions, we show that country risk shocks have sizable effects on the South African business cycle. We also explore the optimal monetary policy implications of our model within the context of Taylor rules. Copyright (c) 2010 The Authors. Journal compilation (c) 2010 Economic Society of South Africa.

Forecasting South African macroeconomic variables with a Markov-switching small open-economy dynamic stochastic general equilibrium model

“…To summarise these results, we firstly note that the coefficients for the model that does not include switching are similar to those of Alpanda et al (2010aAlpanda et al ( ,b, 2011, Steinbach et al (2009) and Ortiz and Sturzenegger (2007). From the results of the Markov-switching model, we note that the central bank favours a greater degree of smoothing when in regime-one.…”

Forecasting Performance of an Estimated Dsge Model for the South African Economy

“…Examples of open‐economy DSGE models that have been constructed for the South African economy include Ortiz and Sturzenegger (2007), Steinbach et al . (2009a) and Alpanda et al . (2010a,b).…”

“…(2009b) show that a DSGE model can outperform the Reuters consensus forecasts for GDP growth over one to seven quarters and for inflation over four to seven quarters 3 . In this paper, we build an open‐economy DSGE model for the South African economy similar to Justiniano and Preston (2010) and Alpanda et al . (2010b).…”

A DSGE-VAR model for forecasting key South African macroeconomic variables

“…For the foreign economy, the Taylor 13 The decision to drop the exchange rate, in either its real form or changes in the nominal value, is due to the available evidence for South Africa on the insignificant role of the variable in the interest rate rule (Ortiz and Sturzenegger, 2007;Alpanda et al, 2010). 14 Alpanda et al, (2010aAlpanda et al, ( , b, 2011) modify this standard UIP condition to allow for a negative relationship between the country risk-premium and the expected depreciation rate, which can account for the forward premium puzzle.…”

“…This technical detail arises because of two assumptions, namely, international asset markets are complete and that the risk premium on domestic assets relative to foreign assets depends on the difference between foreign and domestic demand shocks. As shown in Alpanda et al, (2010a), one can reestimate a model like ours with the rate of depreciation as an observed variable, by adding a country risk premium shock that allows deviations in the UIP between the policy rates in the home and foreign economies. However, at the time of writing, there was no evidence that would suggest that the use of this method, for closing the open-economy features of the model, would provide better out-of-sample forecasting results.…”