Alternative Measures of Exchange Rates and Exchange Rate Policy in South Africa

Abstract

(1) OVER THE PAST SEVERAL YEARS the flexibility of exchange rate policy in South Africa has been increasing. Officials have frequently indicated that a 'market based' exchange rate policy is being followed which the De Kock Commission (1985) has described as a managed float. Certainly fluctuations in the rand exchange rate against all major currencies have increased in the recent past. With this greater variability, however, it has become increasingly difficult to determine exactly what has been happening to the competitiveness of the economy, given the substantial fluctuations in the exchange rates of the major trading partners of South Africa and the difference in their rates of inflation. The purpose of this paper is to examine some alternative measures of the exchange rate changes in order to determine exactly what has taken place in the period since the breakdown of the Bretton Woods system as well as to provide a framework for analysts seeking to make judgements about the appropriateness of the level of the exchange rate. In addition, we will discuss some of the issues surrounding the suitability of various exchange rate regimes for South Africa and measure whether in fact policy has become more flexible in the recent past. Calculation of Effective Exchange RatesIn the fixed exchange rate world that existed prior to 1971, exchange rate developments could be satisfactorily described in terms of the numeraires of the international monetary system -fine ounce gold equivalents or the dollar exchange rate. In a world of variable gold prices and frequent exchange rate changes, however, using a bilateral exchange rate no longer gives an accurate indication of the effects of movements in a country's exchange rate. For example, if the rand depreciates against the U. S. dollar by 10 per cent but the dollar appreciates against all other currencies by 20 per cent, then changes in the rand/dollar rate alone would indicate an increase in the competitiveness of the rand when in fact it has lost competitiveness both in the United States and in the rest of the world. As a result, a number of alternative measures have been developed to give a more accurate indication of exchange 1985 SAJE v53(4) p352 rate movements. The most widely used of these is the so-called trade weighted exchange rate (also known as the effective exchange rate). In its simplest form, bilateral trade weights are calculated and then multiplied by exchange rate changes in order to obtain a weighted average index of exchange rate movements. Many alternative weighting schemes can be used, depending on the use to which the calculations are to be put and the amount of data available. As Rhomberg (1976, p. 69) has pointed out: 'The proper choice of weights for an index of the effective exchange rate depends on its purpose. An index of the effective exchange rate intended to be used in connection with estimation or analysis of exchange rate effects on the trade balance has to use as weights some estimates, however imperfect, of the relative influence of changes...

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