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Financial asset prices, linear and nonlinear policy rules. An In-sample assessment of the reaction function of the South African Reserve Bank

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  • Ruthira Naraidoo

    ()
    (Department of Economics, University of Pretoria)

  • Kasai Ndahiriwe

    ()
    (Department of Economics, University of Pretoria)

Abstract

In this paper we provide an in-sample assessment of how the South African Reserve Bank (SARB) sets policy rate in the context of both linear and nonlinear Taylor type rule models of monetary policy. Given the controversial debate on whether central banks should target asset prices for economic stability, we investigate whether the SARB policy-makers pay close attention to asset and financial markets in its policy decisions. The main findings are that the nonlinear Taylor rule improves its performance with the advent of the financial crisis, providing the best description of in-sample SARB interest rate setting behaviour. The SARB policy-makers pay close attention to the financial conditions index when setting interest rate. The SARB’s response of monetary policy to inflation is greater during business cycle recessions with not much weight on output and seems to place high importance on inflationary pressures of output during boom periods. The 2007-2009 financial crisis witnesses an overall decreased reaction to inflation, output and financial conditions amidst increased economic uncertainty, with a shift from an asymmetric response to financial conditions over recessions to a more symmetric response irrespectively of the state of the economy.

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Bibliographic Info

Paper provided by University of Pretoria, Department of Economics in its series Working Papers with number 201006.

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Length: 27 pages
Date of creation: Mar 2010
Date of revision:
Handle: RePEc:pre:wpaper:201006

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Keywords: monetary policy; nonlinearity; financial conditions index;

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Cited by:
  1. Goodness C. Aye & Rangan Gupta & Mampho P. Modise, 2012. "Do Stock Prices Impact Consumption and Interest Rate in South Africa? Evidence from a Time-Varying Vector Autoregressive Model," Working Papers, University of Pretoria, Department of Economics 201224, University of Pretoria, Department of Economics.

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