An Analysis of the Importance of Terms of Trade in South Africa Using Impulse Response Function

Abstract

The understanding of the terms of trade is essential as its worsening can cause severe disruptions in any economy. South Africa, as a developing nation and a net importer, coupled with its low contribution to the global export market, is not spared the effects of the volatility of export prices. It is therefore important to observe the effects of a negative shock in the commodity terms of trade on selected key macroeconomic variables. Using quarterly data from the period 1988: Q2 to 2019: Q3, the study adopted the Monte Carlo impulse response function and variance decomposition analyses to examine the path of a given variable that resulted from a negative shock in the terms of trade. The results showed that all the variables responded, as expected, to the shock in the commodity terms of trade, both in the short and long run, and that they all returned to stable states. The study further showed the importance of output growth, exchange rate and investment in explaining the commodity terms of trade decomposition. The study concludes by providing some policy recommendations.