The impact of monetary policy on household consumption in South Africa: evidence from Vector autoregressive techniques

Abstract

This article adds to scarce sub-Saharan African and South African literature on monetary policy transmission mechanisms by looking into: (1) the Keynesian interest rate channel of monetary policy transmission in South Africa, focussing on the behaviour of household credit and household consumption; (2) using the time-varying parameter vector autoregressive (VAR) techniques with stochastic volatility to capture the time-varying nature of the underlying structure of the South African economy to see whether it performs better than the constant parameter VAR in so doing and (3) policy implications emerging from the findings of the study. In testing the hypotheses of the interest rate channel of monetary policy transmission, the aim is to see how household credit and ultimately household consumption have evolved in South Africa: (1) before inflation targeting (1994-1999), (2) after inflation targeting (2000-2007) and (3) during the global financial crisis (2007-2012) in response to different monetary policy positioning. The authors focus on three periods: post transition from apartheid, during inflation targeting and during the global financial crisis, periods which saw changes in the monetary policy stance in South Africa. Quarterly data from 1994Q1 to 2012Q4, constant parameter VAR and time-varying parameter vector autoregressive (TVP-VAR) techniques are used in this study. The use of the TVP-VAR is to capture the time-varying nature of the underlying structure of the South African economy and also to investigate whether it performs better than the constant parameter VAR in so doing. The results show that household credit and consumption declined and stayed negative post transition and after inflation targeting periods of monetary tightening in South Africa - but increased during the global financial crisis, which saw expansionary monetary policy measures aimed at mitigating the negative output gap in South Africa. These changes in household credit and consumption across the different time periods show evidence of the cost of credit effect of monetary policy on household consumption in South Africa. They further reflect the impact of different structural changes and exogenous shocks on monetary policy conduct in South Africa and its pass through effect on household consumption in South Africa. We further conclude that the time TVP-VAR with stochastic volatility performs better than the constant parameter VAR in capturing the time-varying nature of the underlying structure of the South African economy.