To What Extent Do Capital Inflows Impact the Response of the South African Economic Growth to Positive SA-US Interest Rate Differential Shocks?

Abstract

Evidence reveals that an unexpected increase in the South Africa-United States (SA-US) interest rate differential lowers SA economic growth. The actual decline in economic growth is lower than the counterfactual suggests. This implies that the increase in the capital inflows following an unexpected increase in the SA-US interest rate differential does not fully prevent the decline in economic growth. The results suggests that capital inflows due to an unexpected increase in the interest rate differential are not large enough to raise economic growth to fully neutralise the adverse effects of a tight monetary policy stance. An effective outcome is achieved when the adverse effects of the interest rate shocks on growth are fully offset by the beneficial effects of capital inflows in stimulating economic growth. The policy implications are as follows. First, policymakers should quantify the extent to which the interest rate differential compares to other pull factors in attracting capital inflows. If other factors dominate the influence of the interest rate differential, this offers policymakers the opportunity to adopt alternative policy options, which may have less adverse effects on economic growth. Second, there is a need to understand where the optimal interest rate differential threshold occurs. This will indicate what happens to capital inflows before reaching this limit, at peak and after this threshold point has been reached. In addition, this requires determining whether the interest rate differential threshold differs between the high economic growth scenarios compared to that in exceptionally low growth or recessionary environment. The understanding of these threshold effects strengthens the importance attached to the interest rate differential in periods of asynchronised economic growth.