Interactions Between Business Cycles, Financial Cycles and Monetary Policy in South Africa

This study set out to investigate the interactions between business cycles, financial cycles and monetary policy in South Africa. Explicitly, the study aims to examine the role of financial factors in business cycle models and the possibility of a unified macroeconomic framework in South Africa. Further, the study assesses the effects of demand shocks, supply shocks, interest rate shocks, and financial shocks on macroeconomic fluctuations. The study applied an analytical approach integrating the Generalised Method of Moments and System Generalised Method of Moments with a Structural New Keynesian Dynamic Stochastic General Equilibrium framework. Accordingly, it was concluded that the financial cycle plays a significant role in business cycle models and is a main driver of macroeconomic fluctuations in South Africa. Further, a unified macroeconomic framework for monetary policy analysis that links the financial system to the real economy in South Africa possibly exists. This study contributes to the South African Reserve Bank’s efforts by deepening understanding of the interactions between the financial system and the real economy and their implications for monetary policy in South Africa. By comparing the standard Taylor rule with a finance-augmented Taylor rule in a DSGE framework, the study helps answer the question of whether financial stability should be adopted as a second objective of monetary policy.