The exploration of the divine coincidence in South Africa.

Abstract

This study looks at the divine coincidence. The study explores the assumption that the central bank does not have to face a trade-off between stabilizing the inflation rate and reducing the output gap. In the context of South Africa, the government has struggled to place the economy on a strong growth trajectory, which has led to a debate about the effectiveness of monetary policy. The sample period under analysis spans from 2000 to 2024 – which is a period in which the South African Reserve Bank (SARB), has been pursuing inflation targeting. The parameters in this study are calibrated using the parameters available in South African literature for the period 2000 to 2024. The study uses a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) framework. The first objective explored whether the divine coincidence holds in the South African economy. The second objective incorporates a technology shock to determine its effect on inflation and output while the central bank stabilizes inflation. In addition, a cost-push shock was incorporated as it is a significant determinant of inflation in South Africa. The third objective to determine the weight the central bank places when responding to the inflation rate. While this is a counterfactual estimation, it allows for policymakers to observe the effects of achieving both price stability and output gap reduction with a technological shock. The results show that the divine coincidence does not hold in South Africa. Secondly, inflation decreases and output increases in the event of a technology shock. Lastly, the central bank puts more weight on stabilizing inflation relative to stabilizing output. The study provides insight on how managing the inflation rate and reducing the output gap simultaneously can lead to economic growth and reduce unemployment as a natural consequence. The non-existence of the divine coincidence is not a crisis for the SARB, however it prompts policymakers to take an approach or adopt strategies that manage the trade-off, while supporting economic growth. This responsibility however, cannot rest solely on the SARB.