Macro modelling
Working paper

Does exchange rate volatility reduce South African domestic consumption?

Nancy Mukalayi
January 2021

This paper analyses how exchange rate volatility affects domestic consumption. It uses a Bayesian vector autoregression model to measure impulse response, based on South African data from 1990 to 2016, which helps to detect how domestic consumption reacts to shocks in exchange rate volatility and other economic variables. Variables such as gross domestic product, inflation, and interest rate are used to explain movement in domestic consumption. The exchange rate volatility series is generated using the GARCH(1,1) approach. A one-unit shock in exchange rate volatility is found to temporarily decrease domestic consumption. This negative response gradually increases until the middle of second period, when it hits its steady-state value. The forecast error variance decomposition shows that exchange rate volatility, domestic consumption, inflation, and interest rate are typically driven by their own shocks, particularly exchange rate volatility in the first period, while the historical decomposition in respect of domestic consumption shows that exchange rate volatility shocks and inflation shocks appear to represent the bulk of domestic consumption fluctuations.

Download SA-TIED Working Paper #160