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Identifying an index of financial conditions for South Africa

Author

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  • Kirsten Thompson
  • Renee Van Eyden
  • Rangan Gupta

Abstract

Purpose - – The purpose of this study is to construct a financial conditions index (FCI) for the South African economy to enable the gauging of financial conditions and to better understand the macro-financial linkages in the country. The global financial crisis that began in 2007-2008 demonstrated how severe the impact of financial markets’ stress on real economic activity can be. In the wake of the financial crisis, policy-makers and decision-makers across the world identified the critical need for a better understanding of financial conditions, and more importantly, their impact on the real economy. Design/methodology/approach - – The FCI is constructed using monthly data over the period 1966 to 2011, and is based on a set of 16 financial variables, which include variables that define the state of international financial markets, asset prices, interest rate spreads, stock market yields and volatility, bond market volatility and monetary aggregates. The authors explore different methodologies for constructing the FCI, including full sample and rolling-window principal components analysis. Furthermore, the authors investigate whether it is beneficial to purge the FCI of the real effects of inflation, economic growth and interest rates, and evaluate the performance of our constructed FCIs by comparing their ability to pick up turning points in the South African business cycle, and by running in-sample causality (forecast) tests. Findings - – The authors find that the estimated FCIs are good predictors of economic activity; with the rolling-window FCI being the “best” performing index. Causality tests indicate that this FCI is a good in-sample predictor of industrial production growth and the Treasury Bill rate, but a weak predictor of inflation. Practical implications - – The authors find that the resulting FCI can act as an “early warning system”. This, in turn, may serve to indicate that monetary policy should take broader financial conditions into account. Originality/value - – This study offers three main contributions to the existing literature on financial conditions in South Africa: the authors construct an FCI over a sample period that is three decades longer than existing indices, the FCI of this paper comprises a wider coverage of financial variables than others and the authors make use of rolling-window estimation techniques that allow them to account for parameter instability and to capture the real-time constraints faced by a policymaker.

Suggested Citation

  • Kirsten Thompson & Renee Van Eyden & Rangan Gupta, 2015. "Identifying an index of financial conditions for South Africa," Studies in Economics and Finance, Emerald Group Publishing Limited, vol. 32(2), pages 256-274, June.
    • Handle: RePEc:eme:sefpps:v:32:y:2015:i:2:p:256-274
    DOI: 10.1108/SEF-07-2013-0098
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    References listed on IDEAS

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    2. Balcilar, Mehmet & Thompson, Kirsten & Gupta, Rangan & van Eyden, Reneé, 2016. "Testing the asymmetric effects of financial conditions in South Africa: A nonlinear vector autoregression approach," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 43(C), pages 30-43.
    3. Umit Bulut, 2016. "Do Financial Conditions have a Predictive Power on Inflation in Turkey?," International Journal of Economics and Financial Issues, Econjournals, vol. 6(2), pages 621-628.
    4. Thanda Sithole & Beatrice D. Simo-Kengne & Modeste Some, 2017. "The role of financial conditions in transmitting external shocks to South Africa," International Economics, CEPII research center, issue 150, pages 36-56.
    5. Gupta, Rangan & Ma, Jun & Risse, Marian & Wohar, Mark E., 2018. "Common business cycles and volatilities in US states and MSAs: The role of economic uncertainty," Journal of Macroeconomics, Elsevier, vol. 57(C), pages 317-337.
    6. Balcilar, Mehmet & Gupta, Rangan & van Eyden, Reneé & Thompson, Kirsten & Majumdar, Anandamayee, 2018. "Comparing the forecasting ability of financial conditions indices: The case of South Africa," The Quarterly Review of Economics and Finance, Elsevier, vol. 69(C), pages 245-259.
    7. Alain Kabundi & Asithandile Mbelu, 2021. "Estimating a time-varying financial conditions index for South Africa," Empirical Economics, Springer, vol. 60(4), pages 1817-1844, April.

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