We build a small open economy New Keynesian dynamic stochastic general equilibrium model for South Africa similar to Steinbach "et al". We abandon their assumption of complete risk sharing with the foreign economy, and introduce country risk shocks to allow deviations from uncovered interest rate parity. These changes allow us to include the exchange rate as an observable variable in the estimation of the model. Using forecast error variance decompositions and historical decompositions, we show that country risk shocks have sizable effects on the South African business cycle. We also explore the optimal monetary policy implications of our model within the context of Taylor rules. Copyright (c) 2010 The Authors. Journal compilation (c) 2010 Economic Society of South Africa.

We construct a small open‐economy New Keynesian dynamic stochastic general equilibrium (DSGE) model for South Africa with nominal rigidities, incomplete international risk sharing and partial exchange rate pass‐through. The parameters of the model are estimated using Bayesian methods, and its out‐of‐sample forecasting performance is compared with Bayesian vector autoregression (VAR), classical VAR and random‐walk models. Our results indicate that the DSGE model generates forecasts that are competitive with those from other models, and it contributes statistically significant information to combined forecast measures.

This paper considers the forecasting performance of a nonlinear dynamic stochastic general equilibrium (DSGE) model. The results are compared to a wide selection of competing models, which include a linear DSGE model and a variety of vector autoregressive (VAR) models. The parameters in the VAR models are estimated with classical and Bayesian techniques; where some of the Bayesian models are augmented with stochastic-variable-selection, time-varying parameters, endogenous structural breaks and various forms of prior-shrinkage (where the Minnesota prior is included as a special case). The structure of the DSGE models follow that of New-Keynesian varieties, which allow for nominal and real rigidities. The nonlinear DSGE model makes use of the second-order solution method of Schmitt-Grohé and Uribe (2004) and a particle filter is used to generate values for the unobserved variables. Most of the parameters in these models are estimated using maximum likelihood techniques. The models are applied to the macroeconomic data of South Africa, which is classified as an emerging market economy. The initial in-sample period of 1960Q1 to 1999Q4 is used to generate an eight-step ahead forecast. The models are then estimated recursively, by extending the in-sample period by a quarter, to generate successive forecasts over the out-of-sample period, 2000Q1 to 2011Q4. We find that the forecasting performance of the nonlinear DSGE model is almost always superior to that of the linear counterpart; particularly over longer forecasting horizons. The nonlinear DSGE model also outperforms the selection of VAR models in most cases.JEL Classifications: E0; C5; C11; C61; C63

This paper provides an investigation into the spillover effects of exchange rate returns and volatility for developed and emerging market currencies, using data from 1997 to 2011. The results suggest that spillovers in exchange rate returns have increased steadily over time, in moderate reaction to economic events. In contrast, spillovers in total observed volatility (measured by squared returns) react more strongly to economic events, and this transmission has remained at a relatively high level since the global financial crisis. Furthermore, over the course of time, global shocks would appear to account for a larger proportion of aggregate exchange rate volatility (and the relative importance of domestic shocks has declined). The paper also considers whether the increase in volatility spillover is due to sudden shocks, or whether it is due to changes in the stochastic trend of the underlying volatility process. The results suggests that in most cases, this increase is due to sudden shocks, however, in certain instances country-specific events may perpetuate changes to the trend of the underlying volatility spillover. JEL Classification: E00, C0, E4, F31, D53

Measures of core inflation convey critical information about an economy. They have a direct effect on the policy-making process, particularly in inflation-targeting countries, and are utilized in forecasting and modelling exercises. In South Africa the price indices on which inflation is based have been subject to important structural breaks following changes to the underlying basket of goods and the methodology for constructing price indices. This paper seeks to identify a consistent measure of core inflation for South Africa using trimmed-means estimates, measures that exclude changes in food and energy prices, dynamic factor models and wavelet decompositions. After considering the forecasting ability of these measures, which provide an indication of expected second-round inflationary effects, traditional in-sample criteria were used for further comparative purposes. The results suggest that wavelet decompositions provide a useful measure of this critical variable.JEL Classifications: C43, E31, E52