South African central bank made important changes to forecasting model

01 November 2018 - 13:10 By Alexander Winning
South African Reserve Bank. File photo
South African Reserve Bank. File photo

The South African Reserve Bank made changes in one of its main forecasting models earlier this year that should result in the model predicting less persistent inflation and fewer rate hikes after a spike in inflation.

The changes to the Quarterly Projection Model, a tool used by the central bank's Monetary Policy Committee, were made before the bank's July rate meeting. They were only made public in a little-known economic bulletin in September.

Analysts say the changes should improve the credibility of the model's forecasts.

"You can view modelling and forecasting as a lofty science, but more interesting is to view it as part of the SARB's credibility and communications arsenal. They won't get things right all the time, but they ask interesting questions to guide the MPC," said Peter Attard Montalto, head of capital markets research at Intellidex.

The new model incorporates a better treatment of inflation expectations and a more reliable wage measure, making it more accurate, the Reserve Bank said.

The bank used the example of a 1 percent shock to core inflation to illustrate the changes. The model shows that after the bank raises its main lending rate in response to the spike in inflation, both inflation and the repo rate fall faster than under the previous model.

"The previous version entailed implausibly persistent shock effects, sometimes lasting almost eight years," it said.

The Reserve Bank said the changes to the model had little effect on its July and September forecasts. A weaker rand assumption and a more negative output gap estimate had more significant effects on the forecasts, it said.

In September, the implied path of policy rates generated by the bank's Quarterly Projection Model was for five rate increases of 25 basis points by the end of 2020.