Evaluating South African Fiscal and Monetary Policy Trade-offs Using a Wavelet-Based Model

Abstract

The balance between South African fiscal and monetary policy in an open economy context poses some interesting questions for policymakers: questions such as whether more aggressive monetary or fiscal policy will likely deliver better growth prospects in the short and medium run, and what will the consequences be for the real exchange rate and for inflation? This research applies wavelet analysis to post-apartheid South African quarterly macroeconomic data, and uses the decomposition to simulate a large state-space linear-quadratic tracking model. We find that restricted fiscal policy is the best option to realise growth, leading to lower interest rates, lower inflation, real exchange depreciation and improved trade balances compared to restricted monetary policy.