An Econometric Analysis of the Relationship between Changes in Government Bonds, Exchange Rate and Inflation Dynamics in South Africa

Sanusi K A,Meyer D F

doi:10.22610/jebs.v10i4(j).2416

Abstract

The study examined the dynamic interaction between government bonds, exchange rate and inflation in South Africa. The study follows a quantitative research method, using monthly time series data from 2007 to 2017 within the framework of a Vector Autoregressive Analysis (VAR). Evidence from the empirical analysis shows that government bond accounts for significant variation in the exchange rate and inflation rate within the study period. The causality test also suggests the presence of uni-directional causal relationships from government bonds to exchange rate, and also to the inflation rate. The principal conclusion that emanates from the empirical analysis is that government bonds are an important policy instrument in the management of the exchange rate and the inflation rate in South Africa. The study recommends that the South African Reserve Bank is a coordinator of government bond and should carry out an in-depth analysis of the economic conditions before issuing the government bonds, taking into account its impeding effects on the exchange rate and inflation rate and many other macroeconomic variables.

Highlights

Due to increased government spending over the years, and with the inability of the revenue to match the upward trend in government spending, the government usually raises funds to finance the deficits through several means such as bond issuing, and seigniorage amongst others
The results indicated that the exchange rate was significantly influenced by the external debt while no such evidence was found for the world oil prices
The raising of bonds by government often hinders the performance of other economic fundamentals such as inflation and exchange rate among others as encapsulated in the theoretical literature

Summary

Introduction

Due to increased government spending over the years, and with the inability of the revenue to match the upward trend in government spending, the government usually raises funds to finance the deficits through several means such as bond issuing, and seigniorage amongst others. An economy with large public debts perhaps by means of uncontrolled high government spending or leakages, is unattractive to foreign investors. This is because debt encourages high inflation which makes debt to be serviced and eventually paid off with cheaper real dollars in the future (Koller, Goedhart & Wessels, 2010; Cavallo & Fernández-Arias, 2013). The majority of these empirical studies did not consider the roles of the internal debt in exchange rate behavior and the resultant effect on inflation was not given much attention.

Literature Review

Methodology

Findings

Conclusion and Recommendations