Development of a financial computable general equilibrium model for South Africa

Abstract

This thesis introduces a financial module into a dynamic computable general equilibrium (CGE) model for South Africa. The new hybrid model, University of Pretoria General Equilibrium Finance Model (UPGEM-F), integrates real and financial aspects of the South African economy. This provides a relatively broader description of the economy-wide effects of the shocks compared to conventional CGE models. The real side of the model is anchored in the theoretical specification of the standard University of Pretoria General Equilibrium Model (UPGEM) that recognises many industries and commodities, alongside other economic actors. The financial side of the model considers the following agents, i) the South African Reserve Bank (SARB), ii) commercial banks, iii) the rest of the world, iv) general government, v) households, vi) industries (excluding housing), vii) non-bank financial institutions, viii) established housing, and ix) new housing developments. Additionally, the model recognises five financial instruments: i) notes and coins, ii) deposits and loans, iii) equity, iv) bonds, and v) gold and special drawing rights. The model uses economic data mainly from Statistics South Africa and the South African Reserve Bank. Two simulations are run to showcase the application of UPGEM-F. The first simulation assesses the economy-wide impact of a decrease in monetary inflows to South Africa from the rest of the world, following a downgrade to South Africa’s credit rating. In this application, the cost of investment increases with the increase in the country’s investment risk. This leads to a decrease in investment and a plunge in economic activity and factor incomes. This is consistent with the results of a standard UPGEM model, but UPGEM-F provides nuanced linkages between financial and real sectors of the economy. The second simulation assesses the economy-wide impact of an increase in assets held by the SARB, among other things, through bond purchases. This simulation results in a decrease in the interest rate, which, in turn, stimulates investment and improves aggregate demand. This sparks an increase in employment as well as private and public consumption.