Prepared by Nikolay Gueorguiev.
For a detailed description, see Kumhof and Laxton (2007).
Throughout the note, we will use interchangeably the term pairs intertemporally-optimizing (overlapping-generations)—higher income households, and liquidity-constrained—lower income households.
See Budget Review 2009, pp. 52-53, Budget Review 2008, p. 47, and the Appendix to Medium Term Budget Policy Statement 2007, all available at http://www.treasury.gov.za/.
As the model has only one commodity sector, which we have chosen to represent South Africa’s exported commodities (mainly platinum group metals, gold, and coal), oil price changes do not directlly reflect the terms of trade.
These rules should be viewed as describing broadly the systematic mode of reaction of fiscal and monetary policies to economic developments rather than as strict rules eliciting automatic policy response.
The higher premium on external borrowing is also one way of accounting for the effects of the large portfolio outflows in late 2008.
We focus on the trade deficit rather than the current account deficit for expositional clarity and because South Africa-specific factors make modeling the dynamics of the non-trade part of the current account difficult.
The immediate effect of the interest rate easing on consumption is limited to consumers with significant net debt. Although household debt exposure is significant, it seems concentrated in upper-income households. A survey shows that consumers with mortgages accounted for only 14 percent of aggregate consumption in 2007.
As South Africa follows an inflation-targeting framework, we let monetary policy respond endogenously to the rise in inflation created by both fiscal and monetary easing (relative to the counterfactual baseline) after the fourth quarter of the simulations.
These “other” revenues can represent, e.g., environment-friendly levies or higher user fees for services provided by the public enterprises, allowing them to recoup part of their investment costs.