Identifying an index of financial conditions for South Africa. Issue 2 (1st June 2015)

• Record Type: Journal Article
• Authors: Thompson, Kirsten; Van Eyden, Renee; Gupta, Rangan
• Is Part Of: Studies in economics and finance. Volume 32:Issue 2(2015)
• Page Start: 256
• Page End: 274
• Publication Date: 2015-06-01
• Subjects: Economics -- Periodicals; Finance -- Periodicals; 330
• DOI: 10.1108/SEF-07-2013-0098
• Languages: English
• ISSNs: 1086-7376

Abstract

<abstract> <title> <x content-type="archive" xml:space="preserve">Abstract</x> </title> <sec> <title content-type="abstract-heading">Purpose</title> <p> – The purpose of this study is to construct a financial conditions index (FCI) for the South African economy to enable the gauging of financial conditions and to better understand the macro-financial linkages in the country. The global financial crisis that began in 2007-2008 demonstrated how severe the impact of financial markets' stress on real economic activity can be. In the wake of the financial crisis, policy-makers and decision-makers across the world identified the critical need for a better understanding of financial conditions, and more importantly, their impact on the real economy. </p> </sec> <sec> <title content-type="abstract-heading">Design/methodology/approach</title> <p> – The FCI is constructed using monthly data over the period 1966 to 2011, and is based on a set of 16 financial variables, which include variables that define the state of international financial markets, asset prices, interest rate spreads, stock market yields and volatility, bond market volatility and monetary aggregates. The authors explore different methodologies for constructing the FCI, including full sample and rolling-window principal components analysis. Furthermore, the authors investigate whether it is beneficial to purge the FCI of the real effects of inflation, economic growth and interest rates, and evaluate the performance of our constructed FCIs by comparing their ability to pick up turning points in the South African business cycle, and by running in-sample causality (forecast) tests. </p> </sec> <sec> <title content-type="abstract-heading">Findings</title> <p> – The authors find that the estimated FCIs are good predictors of economic activity; with the rolling-window FCI being the "best" performing index. Causality tests indicate that this FCI is a good in-sample predictor of industrial production growth and the Treasury Bill rate, but a weak predictor of inflation. </p> </sec> <sec> <title content-type="abstract-heading">Practical implications</title> <p> – The authors find that the resulting FCI can act as an "early warning system". This, in turn, may serve to indicate that monetary policy should take broader financial conditions into account. </p> </sec> <sec> <title content-type="abstract-heading">Originality/value</title> <p> – This study offers three main contributions to the existing literature on financial conditions in South Africa: the authors construct an FCI over a sample period that is three decades longer than existing indices, the FCI of this paper comprises a wider coverage of financial variables than others and the authors make use of rolling-window estimation techniques that allow them to account for parameter instability and to capture the real-time constraints faced by a policymaker.</p> </sec> </abstract>