A time series analysis of the ZAR/USD exchange rate.

Abstract

Exchange rates have significant effects on production, trade, employment and many other areas of both a domestic and world economy, so it is very important to understand the factors responsible for their variations. This paper aims to analyze the relationship between the exchange rate of the South African rand / U.S. dollar and the changes of the macroeconomic fundamentals of the two countries, but also to consider whether and how these changes are sufficient for the interpretation and prediction of the exchange rate in the future. It tries to find out the main determinants of the nominal exchange rate and the dynamic adjustment of the nominal exchange rate covering a time span after the country’s financial liberalization and, especially the last decade with the starting point to be the early 2002. Then a planned military coup by a white supremacist movement known as the Boeremag (Boer Force) was foiled by the South African police. With two dozen conspirators including senior South African Army officers arrested and the extremist organization dismantled, South African police proved to be so effective that strengthened public perceptions that the democratic order was irreversible. The study begins with an updated background on the economy and the exchange rate system in South Africa and provides a brief review of literature on the determinants of the exchange rate. An empirical model linking the exchange rate to its theoretical determinants is then specified to provide robust long run effects and short run dynamic effects on the exchange rate. To undertake an econometric investigation, quarterly data of the period from the first quarter of 2002 to the fourth quarter of 2012 from the database of the International Statistical Yearbook (ISY) / International Monetary Fund (IMF) Statistics are used through Gretl econometric analysis program, facing the South African rand as the domestic currency and the U.S. dollar as the foreign currency. The paper, first, tries to verify the applicability of the theory of Purchasing Power Parity, according to which the evolution of the exchange rate is positive and proportional to the difference in the evolution of the price level. Then, it examines whether the differential of the yield curve, which is a measure of the difference between the interest rates on short-term loans (or bonds) and those on long-term loans (or bonds), has additional power for the exchange rate determination. Subsequently, it estimates the speed at which the exchange rate converges toward its equilibrium level and, correspondingly, the gap between the actual and the equilibrium levels.