The impacts of public expenditure innovations on real effective exchange rate volatility in South Africa

This study examines the impacts of public expenditure innovations on exchange rate volatility in South Africa, utilizing quarterly data from 1970 to 2019. To achieve this objective, a vector autoregressive impulse response model variant, proposed by Jordà, is employed, with innovations identified recursively. The impulse response functions reveal that public expenditure innovation has a decreasing but insignificant impact on exchange rate volatility, and its impact depends on the type of fiscal expenditure innovation. While the impact of public expenditure innovation on exchange rate volatility does not depend on the direction of the innovation, it varies according to the state of the economy. Public expenditure innovation reduces exchange rate volatility during economic upturns but tends to increase it during downturns. Additionally, the size of the impact is greater during upturns than downturns.This study provides novel empirical evidence on the dynamic and asymmetric effects of discretionary public expenditure on exchange rate volatility in South Africa. By employing a local projection method with VAR-identified fiscal shocks over five decades, the findings reveal that public consumption and investment have distinct and regime-dependent impacts on exchange rate volatility. The results offer actionable insights for countercyclical fiscal policy design, emphasizing the importance of timing and composition of expenditure in mitigating currency volatility in emerging economies.