Financial assets, linear and nonlinear policy rules: An in-sample assessment of the reaction function of the South African Reserve Bank

Ndahiriwe Kasaï; Ruthira Naraidoo

doi:10.1108/01443581211222644

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Journal of Economic Studies

ISSN: 0144-3585

Online from: 1974

Subject Area: Economics

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Financial assets, linear and nonlinear policy rules: An in-sample assessment of the reaction function of the South African Reserve Bank

Document Information:
Title:	Financial assets, linear and nonlinear policy rules: An in-sample assessment of the reaction function of the South African Reserve Bank
Author(s):	Ndahiriwe Kasaï, (Department of Economics, University of Pretoria, Pretoria, South Africa), Ruthira Naraidoo, (Department of Economics, University of Pretoria, Pretoria, South Africa)
Citation:	Ndahiriwe Kasaï, Ruthira Naraidoo, (2012) "Financial assets, linear and nonlinear policy rules: An in-sample assessment of the reaction function of the South African Reserve Bank", Journal of Economic Studies, Vol. 39 Iss: 2, pp.161 - 177
Keywords:	Banks, Economic policy, Financial Conditions Index, Monetary policy, Nonlinearity, South Africa
Article type:	Research paper
DOI:	10.1108/01443581211222644 (Permanent URL)
Publisher:	Emerald Group Publishing Limited
Acknowledgements:	JEL classification – C51, C52, C53, E52, E58. The authors thank an anonymous referee and the Editor for their helpful comments, seminar participants at the University of Pretoria, participants at the African Econometric Society Conference and the Economic Society of South Africa Conference for valuable feedback.
Abstract:	Purpose – The purpose of this paper is to investigate how the South African Reserve Bank (SARB) sets monetary policy rate. Design/methodology/approach – Given the controversial debate on whether central banks should target asset prices for economic stability, the authors analyse whether the SARB policy-makers pay close attention to asset and financial markets in its policy decisions in the context of both linear and nonlinear Taylor type rule models of monetary policy. Findings – The main findings are that the nonlinear Taylor rule provides the best description of in-sample SARB interest rate setting behaviour as the financial crisis unfolds. The SARB policy-makers pay close attention to the financial conditions index when setting interest rates. The SARB's response of monetary policy to inflation is greater during business cycle recessions with not much weight on output and seems to place high importance on inflationary pressures of output during boom periods. The 2007-2009 financial crisis witnesses an overall decreased reaction to inflation, output and financial conditions amidst increased economic uncertainty. Originality/value – This paper introduces a financial condition index into a Taylor monetary policy rule and examines whether nonlinear models can provide additional information over a linear model.