Monetary policy, asset prices and consumption : evidence from South Africa using the (FAVAR) approach

Abstract

This study is an addition to the useful application of the FAVAR method in estimating the effects of monetary policy shocks on the economy. It also fills a gap to the literature on the wealth channel effect of monetary policy through shocks on stock prices. We recognize further that very little work has been done in analyzing this wealth channel on African countries and therefore aim to provide explanations using the South African economy. We find results consistent with economic theory and literature using a few macroeconomic data variables on the South African economy. Firstly, consumption is a slow-moving variable and it takes at least one quarter before households completely adjust their consumption habits in response to the interest rate shock. We also find that interest rate changes vary the opportunity cost of holding money causing households to shift their money balances in response to the policy shock. This means consumption and short-term monetary policy shocks have a negative correlation. We also find asset markets to be weak form efficient, that is, stock prices react efficiently to policy announcements but with a lag. The speed of adjustment is delayed. This explains the results obtained which show a smooth concave response which means asset prices react positively to interest rate shocks in the short run, and negatively in the long-run.