Surging commodity prices explain a lot

The surge in commodity prices is strongly correlated with upward surprises in global inflation outcomes and a major driver of emerging market exchange rate appreciation, including the rand. For South Africa, the improvement in the terms of trade have significantly improved the current account, boosted real incomes and welfare as well as the fiscus, and aided the recovery from the COVID-19 pandemic. Higher commodity prices have increased the cyclical fiscal revenue component to nearly 5% of GDP in 2020/21 thereby almost fully offsetting the negative effects of the conventionally-measured increase in the output gap (caused by lower consumption and production). If the revenue boost from the terms of trade unwinds before other spending and growth have increased (and the output gap has closed), fiscal deficits will increase sharply. We estimate an income gap and use a command GDP concept to show that demand may be less suppressed than suggested by the output gap. Nonetheless, given the size of the boost to income, factors such as higher taxes and more saving lean against higher spending. In these conditions, monetary policy may have limited impact.