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Current Account Dynamics and Monetary Policy Transmission in South Africa

Author

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  • J. Paul Dunne

    (School of Economics, University of Cape Town)

  • Christine S. Makanza

    (School of Economics, University of Cape Town)

Abstract

The debate on global current account imbalances has become more pronounced with the change in global monetary conditions following the 2008 financial crisis. Emerging markets are at a greater risk of being affected by these changes as they have weaker macroeconomic fundamentals and are less insulated against external shocks. This implies they are at a greater risk of adverse effects of normalisation of monetary policy as this may result in an outflow of capital. Despite these risks, there is a lack of investigation into the consequences of monetary policy for current account deficits in emerging economies. This study covers this gap by estimating SVAR models to analyse the effect of monetary policy on current account dynamics in South Africa. South Africa is used as an attractive emerging market case study because of the large current account deficit and dataset that has so far not been exploited to understand the external balance. The study analyses the effect of foreign and domestic monetary shocks on current account developments so as to determine whether changing global monetary policy warrants any intervention of the current account in emerging markets. The study goes further to analyse the channels through which monetary shocks are transmitted to the current account so as to determine how the savings investment gap is affected by monetary policy. Our main contribution is in providing an understanding of the relationship between the current account and monetary policy in emerging markets, and uncovering the effects of global monetary policy on emerging market current accounts. Our analysis shows that the current account is affected by global monetary shocks, with higher foreign interest rates resulting in a lower current account deficit, suggesting that the normalisation of US monetary policy could result in a sharp current account reversal.

Suggested Citation

  • J. Paul Dunne & Christine S. Makanza, 2016. "Current Account Dynamics and Monetary Policy Transmission in South Africa," School of Economics Macroeconomic Discussion Paper Series 2016-02, School of Economics, University of Cape Town.
  • Handle: RePEc:ctn:dpaper:2016-02
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