Abstract
This paper estimates and contrasts the effects of contractionary monetary policy shocks on output in South Africa and South Korea, using a sign restriction VAR approach. I use quarterly data spanning 1980Q1 to 2010Q3. I investigate how much output movements are induced by monetary policy shocks. The main findings reveal that contractionary monetary policy shock significantly depresses real output for many quarters in South Africa. However, output declines insignificantly and transitorily in South Korea, indicating monetary neutrality. I attribute this difference to the transitory responses of both the monetary aggregate M2 and the exchange rate to a monetary policy shock in South Korea compared to South Africa. This implies that each country, despite targeting inflation, has a different monetary policy reaction function. Evidence shows that the monetary policy shocks explain a large portion of fluctuations in output in these emerging market economies compared to those reported for advanced countries by Uhlig (J Monet Econ 52(2):381–419, 2005) and Rafiq and Mallick (J Macroecon 30:1756–1791, 2008). Lastly, I examined the reasonableness of the estimated monetary policy shocks. Evidence indicates that the estimated monetary policy disturbances capture certain monetary policy activities based on selected major historical and recent real-time macroeconomic shocks.
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Notes
For instance, the authorities can speed up the accumulation of foreign reserves to appreciate the currency and dampen inflationary pressures via lowering the exchange rate passthrough to import prices. This is a plausible channel, which can explain the different duration of their policy effects and the path of the interest rate in the two countries.
The spot interventions are used to smooth the exchange rate volatility, while the swap market interventions are used to supply dollar liquidity in the market. These interventions are done by agents selected from amongst banks as the Korean Ministry of Finance and Economy can tap into the foreign exchange rate stabilization fund to stabilize the exchange rate (Rhee and Lee 2005; Ryoo et al. 2013).
I subject the findings to robustness testing using the penalty function developed by Uhlig (2005), and the results are not presented here.
I did the analysis for the maximum and minimum bounds for K = 1, 2, 3, 4, 5, 6, 7, 8 quarters in reaction to a contractionary monetary policy shock of one standard deviation in size. The results are available from the author upon request.
The structural shocks are calculated from \(e_{t} = b^{\prime}u_{t}\) where b is the row of \(A_{t}^{ - 1}\)\(e_{t}\) and is the structural shocks and ut are the residuals from the reduced form model. At is made up of impulse vectors.
Data are obtained from the IMF IFS database.
A counterargument suggests that it is plausible that a positive supply shock could result in higher prices when the supply shock makes monetary authorities loosen monetary policy by more than what is required (Rafiq and Mallick 2008).
Oil prices provide central banks with information about future inflation from the real disturbances (Sims 1992).
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Ndou, E. The effect of monetary policy on output using sign restriction VAR: evidence from South Africa and South Korea. Empir Econ 64, 1979–2003 (2023). https://doi.org/10.1007/s00181-022-02293-7
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DOI: https://doi.org/10.1007/s00181-022-02293-7