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Title: Financial and real economy interactions in South Africa : a stock and flow analysis
Author: Makrelov, Konstantin Hristov
ISNI:       0000 0004 6500 5646
Awarding Body: SOAS University of London
Current Institution: SOAS, University of London
Date of Award: 2017
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This study aims to investigate the impacts on the South African economy of higher government expenditure, capital flow reversal and regulatory changes introducing a higher required leverage ratio for banks. The research framework differs from Dynamic Stochastic General Equilibrium Models as they lack consistent representation of institutional balance sheets and financial sector behaviour. An alternative model which is micro founded and stock and flow consistent in the tradition of Backus et al. (1980) is constructed and calibrated for South Africa. It provides for a richer representation of institutional balance sheets than existing models. The financial sector's behaviour in this framework draws on the recent theoretical models of Borio and Zhu (2012) and Woodford (2010), which highlight the relationship between bank capital, risk taking behaviour of the financial sector, lending spreads and economic activity. The financial accelerator mechanism operates through the balance sheets of all institutions in the economy. Solving for the effects of a fiscal shock, the model generates a government expenditure multiplier larger than two in severe recessionary conditions. Although low levels of domestic savings limit the sources of funding to support the fiscal expansion, foreign saving inflows relax the savings constraint, increase liquidity in the market and support the fiscal expansion. The results from a capital flow reversal shock to the model indicate larger impacts than previous studies. We find that even in the absence of large foreign currency denominated liabilities, a reversal in capital flows can affect the domestic economy through its impact on domestic liquidity, on the risk-taking behaviour of the financial sector and on the demand for assets. The negative effect can be exacerbated if the shock changes the expectation formation process of agents in the economy. The introduction of a higher leverage ratio for banks is likely to generate negative economic impacts in the short-run that depend on the banks' choice of adjustment strategy. The negative GDP effect is the greatest if the financial sector reduces leverage through a reduction in the value of its assets (for example, recall of loans) rather than the issue of new equity. The regulatory shock leads to the financial sector changing its perceptions of risk, which reduces the size of the money multiplier and increases lending spreads. The results indicate the importance of incorporating stock and flow consistent financial sector dynamics in studying macroeconomic shocks. Our results also highlight the importance of the financial sector in transmitting policy interventions and the role of policy in changing the behaviour of the financial sector. Thus, one of our key policy conclusions is that the old model of fiscal and monetary policy coordination is outdated. Effective policy coordination must include macroprudential policy and understanding of the risk behaviour of all institutions in the economy.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral